The Hierarchy of Needs for Mezzanine Debt

Posted on: December 14th, 2020

hierarchy of needs for mezzanine debt

Great thinkers often try to simplify complex concepts into systems of thought. One such attempt is Maslow’s hierarchy of needs which was published in 1943, which proposes a classification system of the universal needs of society. At the bottom of the hierarchy there are basic needs such as food and shelter. In the middle tier there are psychological needs and at the top tier, there is self-actualization.

The tiers are cumulative, and it is not possible to get to the next tier without having the others in place. The top tiers are also narrower, which means they are more scarce and harder to attain. The hierarchy is one way to think about what it means to be a complete person. Similarly, this type of framework can help a company understand what it means to be a complete company especially in the eyes of a mezzanine debt lender.

Hierarchy of Mezzanine Debt

Mezzanine debt lenders have very specific approval criteria hierarchies, which lay out in a tiered, pyramidal fashion. On the bottom tier, there are basic components such deal size, industry, and company size. This tier is wide with many companies fitting into the prospect funnel. Industries such as manufacturing, distribution, technology, healthcare, business services and retail are acceptable. The Company size is usually revenue greater than $20 million and EBITDA greater than $2 million. The deal size is usually a loan of $5 million from a mezzanine debt lender.

The middle tier consists of measurement components such as analysis of historical financial performance, growth projections and deal attractiveness. In this narrower tier, historical and future performance is scrutinized to objectively gauge the company’s ability to service the mezzanine debt. The quality of the deal is measured through assessing cash flow stability, downside risk, and upside return potential. This tier involves both objective and subjective review, and many companies do not make the grade.

The final tier is the most elusive and only the best in breed companies ever make it this far. This tier consists of management quality and information quality. Is the management team complete and highly accomplished? Are the information systems strong and does management have a high information awareness quotient? When mezzanine debt lenders see all three of these tiers in one company, they know they it is a great company that is highly mezzanine debt financeable.

In the acquisition financing arena, capital availability is destiny as companies require reliable access to capital to grow over the long term. Unforeseen capital needs usually arise when acquirers least expect it. This can cause some concern for the acquisition financing provider, especially when covenants tighten up and that working capital availability is utilized faster than expected.

Mezzanine debt borrowing is usually a straightforward activity that many companies use for funding of transitional growth. Mezzanine debt lenders are highly transparent about their due diligence approach and their post-closing loan management making it easy for companies to engage with.

Elections have consequences and positive ones at that for the acquisition financing middle market. While much media attention is paid to the direction of the yield curve and the Fed’s likely rate cuts, scant attention is paid to the more important drivers of the acquisition financing market – business psychology and regulatory climate.