The best way to understand the best capital funding solution is to make certain you are asking the right questions. Any consideration of the pros and cons of various funding paths starts with a deliberative approach to what a company wants to do. Are you looking to grow through acquisition, grow internally, add new customers, and add new products or a combination of all? Do you have personal investment to fund your growth or has the business grown large enough that your personal financial backing is now inadequate. Do you want to de-risk and pull money out of the company via a distribution or do you want to concentrate all of your net worth into the equity value of your company.
The answers to these questions are the starting point to determining the best capital funding solution. Capital funding solutions can be as simple as a line of credit or as complicated as a multiple layer structure of senior debt, mezzanine debt and equity. Within the middle market, most capital funding solutions involve equity investment from a private equity investor. This is often very dilutive and highly restrictive to a business. Most business owners want to own the majority of the shares in their companies and as a result are not interested in working with a private equity investors. In our experience, the best capital funding solutions are the structures that provide an abundance of capital and abundance of flexibility.
Bank loans do not fit this description. Nor does equity investment fit the bill as they want to own most of the shares. Mezzanine lenders usually provide the best combination of capital abundance and loan flexibility. The reason for this is pretty straightforward and centers on their ability to structure their loans against the equity value (as opposed to the asset value) of the enterprise. Most of the income that a mezzanine lender receives comes in the form of a fixed coupon with a small amount in the form of yield enhancement through a warrant kicker. As a result, they can lend you a large amount of money, with flexible terms at a low price. Mezzanine loans are a great capital funding solution, and are widely available in the market for most middle market companies.