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How much debt is too much before opting for mezzanine financing?

A mezzanine financing opportunity arises when the banks can no longer stretch further into the capital structure to fund a deal. The amount of debt that is too much before opting for mezzanine financing is often subjective, but it is usually determined by the bank’s credit standards and risk rating system. Banks like to keep their loans fully collateralized and their leverage multiples down. They also like to see a strong book equity level on the balance sheet. When the leverage multiple gets to about 3 times, most banks will advise their borrowers to consider bringing in mezzanine debt. Mezzanine debt plays the role of quasi-equity on the balance sheet, providing valuable long term capital support at a fraction of the cost of bringing in true equity. The determination by the bank is based on leverage multiples as well as their view of the industry and the quality of the management team. Mezzanine debt is long term capital that is flexible like equity, but at a much lower cost.

Mezzanine debt is a form of subordinated debt, preferred equity, or some mixture of both that is usually wedged between common equity and senior debt in a company’s capital structure. Mezzanine capital providers gauge the companies they lend to based on a subjective and objective analysis. The best way to acquire mezzanine debt is to talk to a well-equipped financial advisor that understands the structure of mezzanine funding and how it would work with your company. Mezzanine financing is usually in the form of a 5-year term loan with interest for only the term. It has no personal guarantee to the owner of the company. It is based on a multiple of the businesses trailing twelve month EBITDA, or earnings before interest, taxes, depreciation and amortization. The standard multiple of EBITDA is around 3.5x.

A company should be aware of how much debt and equity it has in its capital structure. Mezzanine financing can be a strong alternative to stabilize the funding requirements a company’s growth and acquisition strategies.

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