How to Leverage Mezzanine Debt without Handling Over Too Much Control

Mezzanine debt is a potent way to acquisition finance your business through its larger loan size and greater repayment flexibility. It is used most frequently in change of control sell-side transactions but can be applied with great success to founder-owned companies who wish to acquire and need more capital than their bank can provide.

When founders use mezzanine debt, they act like their own private equity firm and use the existing equity value of their company to secure a large acquisition loan. The issue of control is always a hot one for founders. These loans are riskier than bank loans and as a result come with more lender control in the form of stricter covenants and reporting requirements. The key is to not be in a position where you are overly dependent on the mezzanine lender. There are a few ways to set up your deal so that you can keep your mezzanine debt lender slightly off balance so that you are not overly dependent on them.

The first way is by having a senior lender ahead of them in the debt structure. Most mezzanine debt lenders love it when they are the only institutional lender to the company, akin to being home alone. When they play the role of the bank and the mezzanine lender they are functioning as one stop lender and have a very strong position as a secured creditor should they need to protect their interest. When the mezzanine lender has a bank loan ahead of them, they are subject to an intercreditor agreement with the bank whereby their rights are subordinated to the senior lender. The senior lender has the right, in the case of an event of default, to suspend their interest payments and to make them stand still. This is an undesirable state for the mezzanine debt lender that they want to avoid at all costs. This means that the mezzanine debt lender is usually cooperative because they are effectively neutralized from doing anything drastic.

The second way to ensure that they do not exert excessive control, is to make sure that you are not over-reliant on them for future funding. You should always have additional lenders who want to fund you on standby in the event the mezzanine debt lender will not. When you need more money and they think you have no other options, there is a tendency for them to squeeze on the pricing. When you have the credible threat of refinancing them, they tend to fall in line and play ball.