Choosing Between Mezzanine Debt Term Sheets

Posted on: September 28th, 2021

mezzanine debt

All growth-oriented middle market companies have big plans which require large amounts of capital. The capital raise step in funding growth is a mission critical element and requires absolute certainty to ensure a sound and timely scale-up. Mezzanine debt lenders are excellent options for middle market companies when banks regard the capital request as too aggressive.

Mezzanine debt lenders fund beyond the level of bank debt into the cash flow valuation of your company, and frequently can provide all the funding needed to execute your growth plan. Given their role as lenders for transitions, they are well versed in providing capital runway extension for companies undergoing strategic transformation.

Key to Mezzanine Debt Closing

The key to a successful mezzanine debt closing is ensuring you have a large enough pipeline of lenders, so that you have multiple paths to a closing, should one fall over. Even though mezzanine debt lenders are very steady and have very high close rates, the need for capital funding calls for the development of numerous mezzanine debt term sheet options. There are several ways to evaluate these term sheets to make the best selection. The best review approach is a holistic one that considers specific pricing & terms, the level of term sheet customization, required diligence items, and lender enthusiasm for the deal.

Most mezzanine deals are priced within a band of 12% to 15% for an annual return. This return consists of current interest payments, PIK interest accrual and any additional return kicker such as a warrant. Where your deal falls on this range depends on its risk profile and size. Most mezzanine debt structures are 5-year maturities with a minimum interest only period of 2 to 3 years. The standard covenants are leverage ratio and debt service ratio with the former at 3.5 to 4.0 times and the later 1.25 times. Term sheet customization refers to the degree the term sheet is reflective of your specific capital request. If the term sheet appears one-size fits all, then that indicates a cookie-cutter approach by the lender.

Mezzanine debt’s advantage is its flexibility and the ability to provide bespoke structures for the borrower. It makes little sense to work with a mezzanine lender whose approach to loan structuring is standardized.  Required diligence items refer to the remaining open items to close. These often include a quality of earnings review as well as background checks. These items should be clear and straightforward and not read like a never-ending punch list of areas with open-ended scope. While outside the four corners of the term sheet, lender enthusiasm is perhaps the most important of all.

Often, mezzanine debt lenders that really connect with a deal will show a high degree of enthusiasm.   They respond rapidly, they want to meet and get to know you, and they say the deal has a high degree of approvability. Lenders with high enthusiasm are generally the best choice. Their ardor for the deal allows them to overcome any obstacles along the path of their approval process.