Why Mezzanine Debt Seems Mysterious

Mezzanine debt sounds mysterious and hard to grasp. It suffers from a technical name that conveys little meaning to a founder-owned company. Despite its unfortunate name, it delivers in a bold way by funding acquisitions based on three factors that banks are resistant to. These factors include:

Using adjusted trailing twelve-month EBITDA.
Using a multiple of adjusted EBITDA to calculate the loan amount.
Giving additional loans on a delayed draw basis to fund future acquisitions.

The Role of Adjusted Trailing Twelve-Month EBITDA

Mezzanine debt lenders focus on the trailing twelve-month period and allow for adjustments to reflect adjusted EBITDA. The very fact that they can use the most recent trailing twelve-month period and adjustments leads to greater loan sizes for the borrower. Most banks will only use the most recently ended Fiscal period when evaluating a loan and ignore recent earnings growth in the interim period. Banks are also too conversative in disallowing adjustments and often default to only the most straightforward adjustments. Even though a company’s EBITDA may be up 25% on a year over year basis, the banks will not give you the benefit of the growth when coming up with a loan amount due to their internal policies.

Lending Based on Multiples, Not Just Collateral

Mezzanine debt lenders calculate their loan amounts based on a multiple which is unique. This shows that they are making a loan against the intrinsic equity value of the business based on what the company is worth to a buyer based on its growth. Each multiple is calibrated for their view of the risk based on a number of factors. This multiple convention frees them from using asset collateral value to come up with the loan amount. If the adjusted EBITDA for the trailing twelve-month period is $5 million, they are likely to use a 3.0 to a 3.5 times multiple resulting in a loan size of $15 to $17.5 million. They are comfortable making this loan because based on their view of the company and its growth plan, the business is worth 7 to 8 times adjusted EBITDA upon a sale. Lending based on a multiple is a highly differentiating feature and allows mezzanine debt lenders to provide larger loans often funding the entirety of the capital need for an acquisition or a strategic investment.

The Power of Delayed Draw Loans

Finally, because they think of businesses in a growth context based on evolving cash flow scenarios, mezzanine debt lenders also provide delayed draw loans to be used for future acquisitions. It is common for a borrower to receive a commitment for a delayed draw loan equal to or more than their initial loan amount. For example, they make borrow $25 million at close and have an additional $25 million of delayed draw term loan to fund deals down the road. The combination of current adjusted EBITDA with a multiple unlocks loan sizing that drives bold acquisitions both at closing and into the future.

Why Mezzanine Debt Seems Mysterious

Using adjusted trailing twelve-month EBITDA.

Using a multiple of adjusted EBITDA to calculate the loan amount.

Giving additional loans on a delayed draw basis to fund future acquisitions.

The Role of Adjusted Trailing Twelve-Month EBITDA

Lending Based on Multiples, Not Just Collateral

The Power of Delayed Draw Loans

Raising acquisition financing can be bewildering for first timers. Acquisition financing providers are hard to identify in numbers sufficient to yield enough strong prospects. First time companies are not well versed in the presentation standards and process requirements. Like any complex process, it is a journey with different stages that requires the right combination of people, process and commitment.

To the uninitiated, mezzanine financing appears risky, and certainly riskier than a simple bank loan. Given its higher interest rate and larger loan amount, most founders tend to avoid it due to fear of overleveraging. If a company is not used to operating with debt, it does take some adjusting to as mezzanine lenders are more focused on current and future financial performance than most banks are.