The Scalability Factor – The Hidden Benefit of Mezzanine Finance

Posted on: August 24th, 2022

mezzanine finance

Mezzanine debt lenders compete in a lending segment driven by growth transformation including mergers & acquisition and organic growth. This growth transformation lending market is a subset of the larger middle market which includes direct lending, equipment financing and asset-based finance as well. Mezzanine debt lenders charge higher rates for their capital, commonly in the 10% to 12% range. These rates are high compared to banks, but the value of a mezzanine debt lending solution far surpasses that of a bank loan, rendering the comparison apples to oranges.

Mezzanine debt lenders fund into the future growth of a company by underwriting their adjusted EBITDA, allowing them to offer loans based upon cash flow growth, as opposed to static asset values of a bank approach. This alternative structuring approach provides a significantly large capital quantum than an asset-based approach, giving the company the means to scale their business at a much faster rate. This key difference – the scalability factor of a mezzanine loan is continually borne out by market feedback.

Many companies engaged in an acquisition need a quantum of capital pegged to a multiple of EBITDA, not the asset base, of the target. The company may ask their current bank for a loan of $10 million, only to find the bank will lend only $3 million, due to the collateral limitations. A mezzanine debt lender can easily provide $10 million, as long as the loan size is within their EBITDA multiple ranges, usually 3.5 times adjusted EBITDA.

In capital, as in most things in life when you pay more, you usually receive more. By agreeing to a higher interest rate, the buyer unlocks the ability to scale their business through acquisition or hyper growth. This creates a virtuous cycle of growth, wherein a company not only grows larger but also multidimensional in ways of specialization and competitive advantage. Mezzanine debt provides a scalability factor that asset-based loans are unable to deliver.

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.