Mezzanine Funding is a market based completely of loans that are cash flow based. Mezzanine is benchmarked to a Company’s EBITDA and not to its level of collateral. A company that is looking to acquire mezzanine funding has the ability to generate enough cash flow to pay back the principal and interest on the loan over time. Mezzanine lenders focus on cash flow and factor in future cash flow growth when structuring their loans. They are realistic about potential pitfalls and downside risks. Mezzanine lenders are keenly interested in the quality of the Company’s management team and the soundness of the growth plan. Mezzanine funding is most suited for companies that are cash flow rich and able to generate strong returns from deployment of the capital.
The middle market is strong and large. It consists of over 1,000 mezzanine middle market lenders including Small Business Investment Companies (SBICs), public entities such as Business Development Corporations (BDCs), and independent funds. Lower middle market companies often receive their financial capital from a local banking source through a line of credit or simple term loan. However, when a fast growth opportunity or acquisition opportunity presents itself, there can be a greater need for capital than a bank can provide. That’s where the larger lenders such as SBICs and BDCs come in. While senior debt might be a challenge to obtain and opting for equity does not always present a favorable alternative, mezzanine funding fits that gap perfectly.
Mezzanine funding has a large advantage in that it requires only interest payments and no principal payments throughout the first three or four years of the loan. This gives a company much more flexibility with its capital cash flows. In addition, mezzanine loans mature in five to seven years. This provides the end user even more elasticity for its funding. Finally, mezzanine funding is based off of a multiple of the companies EBITDA, often three to four times EBITDA. The amount of funding coupled with the low cost and large amount of structural flexibility, makes mezzanine funding a very attractive option for a strong cash flow business.
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