The Experience Gap Secret of Middle Market Lending

Posted on: March 28th, 2024

mezzanine debt

Buried within the pedigreed bios of mezzanine debt lenders and private equity investors lies a secret plainly obvious to any average joe. While mezzanine debt lenders have strong educational and work backgrounds from large elite institutions, they usually lack real world experience of the kind that is valuable to understanding the businesses they seek to evaluate.

Real world experience means working in an operational or managerial role at a middle market company that immerses one in the daily ebb and flow of how a business really runs. The reality of a middle market company is part proactive management and part seat of the pants, reactive. Real operating experience involves responding to rapid, unexpected change similar to Mike Tyson’s take “everybody has a plan ‘til they get punched in the mouth”. Possessing real world, punched in the mouth operating experience is extremely valuable. It forces a person to solve problems creatively, rapidly, and resiliently as they navigate through a period of stress and uncertainty. They learn a tremendous amount in the process as it relates to implementing changes, leading teams, overcoming resistance, and developing better systems. These are things that need to be experienced firsthand to learn.

Most mezzanine debt or private equity investors have been several levels removed from this type of operating experience in their learnings. In business school they may have read HBS cases which are academic case studies. At big banks or consulting firms, they were part of massive teams, in a detached analyst role never close to the operating action of the companies they worked on. Through this they developed abstract, analytical knowledge akin to virtual business experience. While they know how to think elegantly at a high level, they lack real world knowledge to help them truly understand the businesses coming to them for investment. This experience gap poses a big issue for a company seeking mezzanine debt or private equity.

When the groups lack the ability to understand what you do in the real world as opposed to an analytical basis, it makes it harder to land a good capital provider. They will fail to get comfortable with issues that pop up in due diligence. They will let their lawyers run rough shod on business issues thereby killing a deal. They will fail to have a basic understanding of why certain things were done and develop mistrust of the company. Middle market companies should screen for real world experience on the front end when searching for mezzanine debt or private equity firms. They are easier to work with and provide long lasting financial partnerships.

As the Fed decides to ease interest rates, middle market acquisition financing structures will benefit in a number of ways. The underlying values of middle market companies will increase leading to a higher enterprise value and lower loan to value ratios for existing portfolio companies of acquisition financing lenders.

The role of acquisition financing is infrequently elevated above a functional transactional one. When a business needs financing to acquire, they go to the market and source acquisition financing to supplement their equity investment to close the deal. Despite existing in many different forms, acquisition financing is rarely explained in terms of the value it brings to the acquirer.

Acquisition financing underwriting usually focuses on business and financial issues that underpin the stability of cash flow. Providers of acquisition financing usually validate the durability of a company’s competitive advantage and the depth of its resource base. Environmental issues are usually not a major part of the analysis in today’s service and technology-based economy.