The Top 4 Reasons to Why Mezzanine Debt is Ideal for Strategic Scale-ups

Posted on: June 6th, 2020

mezzanine debt for strategic scale up Mezzanine debt is an elastic form of funding that can help power companies through transitional periods. Mezzanine debt is fundamentally a form of growth financing designed to capitalize business transformations. It can be used to finance buyouts but its most impactful use is facilitating strategic growth scale-ups. Often these scale-ups are regional expansions, new product launches, capacity expansions or complementary acquisitions.

Mezzanine Debt a Financial Cushion

These strategic maneuvers all require significant capital backing and upfront investment across various budget areas. There are new hires, new expenses, new systems and equipment to invest in. Budget amounts to fund strategic scale-ups are usually a big number relative to a company’s available cash. Funding it internally would tighten a company’s liquidity and perhaps alarm your bank lender.

Additionally, time frame factors are a large consideration as most strategic scale ups are long term investments. The pay off is likely 3 to 5 years down the road, and hence it should be match funded with capital that is similarly long term in nature. Using short term cash to fund a long term scale up puts a high level of pressure on your liquidity and prevents you from having an all-important financial cushion.

Most scale-ups defy smooth financial projections and are usually a bit bumpy. For a variety of good reasons, time frames are often extended. This can range from slower sales conversion to longer development or integration timelines.

Regardless of the cause, strategic scale-ups frequently take longer to materialize. The sheer magnitude of capital needed and the importance of having a suitable time runway make mezzanine debt an ideal partner for strategic scale-ups.

Here are Attract Capital’s four reasons why mezzanine debt is ideal for funding your strategic scale-up.

They provide larger loan amounts – mezzanine debt lenders fund off future EBITDA not historical profit or assets. This provides you more capital and allows you to fund deeper into your budget, usually satisfying that hard to fill funding gap. Structured properly, mezzanine debt can provide an equity like level of capital support, at a much lower price than raising expensive equity.
They intuitively understand growth – mezzanine debt lenders are mature and are well versed in all major types of strategic scale-ups. These include platform acquisitions, industry roll-ups, product line diversification, and market channel diversification. Because each growth path is unique, mezzanine debt lenders tailor each loan accordingly.
They are incentivized for growth – mezzanine debt loans require EBITDA growth to fund repayment of loan principal. Additionally, these loans often have small equity kickers that provide extra returns, based on valuation growth. Quite simply, you will likely not get the loan unless your mezzanine debt lender believes strongly in your ability to scale-up.
They use adjusted and pro forma financial numbers – unlike banks that use actual financial results, mezzanine debt lenders use flexible ways to understand the core cash flow of your business. They give you credit for one-time and non-recurring expenses which allow you to increase EBITDA and obtain a larger loan.

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.