Posted on: April 9th, 2022
Within the acquisition financing market, there are different types of business buyers. Mezzanine debt lenders provide capital for acquisitions led by funds as well as non-fund buyers. Non-fund buyers consist of fundless sponsors, independent sponsors, owner-operated businesses, family offices and holding companies. Mezzanine debt lenders usually focus their activities on a few different buyer types to ensure they book enough assets at acceptable rates of return. Before embarking on an acquisition financing round, it pays to understand how the mezzanine debt market classifies your group so you can properly target the right lenders. In addition, it is valuable to understand why they classify you in a certain group. Through understanding their classification thought process you better understand how the mezzanine debt lender thinks about risk.
In general, mezzanine debt lenders consider funds to be private equity funds with significant assets under management. The range of funds under management varies but for middle market deals, it ranges from a low of $75 million to $400 million. These fund buyers invest 30% to 45% equity in their deals and raise bank financing to cover as much of the financing need as possible. Mezzanine debt is used if there is a funding hole beyond what the bank will provide. Mezzanine debt lenders view these deals as low risk due to the implicit put value of the fund investing more equity in the Company, if needed. Private equity funds also bring a level of management and reporting sophistication to the company that is comforting to the mezzanine debt lender.
Mezzanine Debt as Acquisition Financing in Non-fund Buyer Category
Within the non-fund buyer category, two of the most prominent buyer types are the independent sponsor and the owner-operated businesses. Independent sponsors are people or groups who have a track record and capital of their own to invest in a deal. They usually have had prior success and want to replicate this success through acquiring and scaling a new enterprise. Most independent sponsors have capital ranging from $1 million to $3 million of their own to invest, but they do not have a fund. Mezzanine debt lenders like independent sponsors but see these structures as riskier than private equity backed deals. These deals usually have more seller notes and rollover equity, and less cash equity than private equity deals. They also have a weaker implicit put value, as the independent sponsor by definition does not have a large fund for additional equity money. Nonetheless, the independent sponsor model allows the mezzanine debt lender to play a more equity-flavored role in the deal, which they are very happy to do.
With owner-operated businesses, the buyer is the privately held company. Usually there is one or two owners, and they are active in the business and their personal net worth is tied up in the value of the business. In this type of deal, the owner-operated business uses the equity value in their current business to bring in 100% financing from the bank and mezzanine debt lender. The buyer contributes their rollover equity value and there is usually little new cash put in as equity. These deals are viewed as riskier on the structure side due to the lack of cash equity and follow on equity capital. Yet they present less risk on the credit side due to the operational capabilities of the purchasing company. This owner-operated business acquisition model allows the mezzanine debt lender to be a direct lender and a become a long-term capital partner for the company. It also allows the mezzanine debt lender to slightly increase their pricing, and play a more equity-flavored role in the relationship.