Is It Senior Debt or Mezzanine Debt

Posted on: July 5th, 2022

mezzanine-debt

When hunting for acquisition financing, deal sponsors usually talk to many different types of lenders. Early on, there is less focus on the type of debt –senior debt loan vs. mezzanine debt loan, than there is on just starting lender conversations. Eventually structural discussions commence wherein the lender evaluates the capital request according to their credit criteria and their institutional risk preferences. The sponsor’s preliminary view on debt stack composition may conform to market standards, yet the lenders may have a totally different idea on how to skin the cat.

For example, in smaller middle market deals, mezzanine debt lenders often prefer to provide all the debt capital, incorporating the senior debt layer into their mezzanine debt loan. The sponsor may want a senior loan from a bank and a mezzanine loan from a mezzanine lender, but the mezzanine lender is more comfortable providing one loan which subsumes the senior debt layer into the total loan facility. Even though the mezzanine debt loan is more expensive than a senior debt loan, there are benefits to the borrower of having a one stop debt approach. The mezzanine debt lender may even call their loan facility a senior facility, even though it is a true mezzanine debt loan with respect to pricing and structure.

On the other hand, senior debt providers such as banks can provide a loan with structural similarities to a mezzanine debt loan. Banks that provide C&I loans can lend up to 3.5 times adjusted EBITDA, at much lower pricing than mezzanine lenders. The C&I loan may provide the same loan amount as a mezzanine debt loan, which is conventionally much larger than a bank loan. In this case, the bank is lending into the mezzanine debt layer, and subsumes the mezzanine layer into its debt facility without even calling it a mezzanine loan. This all-in-one structuring approach makes the line between senior debt and mezzanine debt quite ambiguous. This underscores the need to go wide in your loan sourcing process to ensure you are speaking to a sizable number of senior lenders and mezzanine debt lenders. There are pros & cons to doing a senior debt loan that includes the mezzanine layer as well as a mezzanine loan that includes the senior layer. The actual label on the loan (senior or mezzanine) matters little. The structural advantages and how the loan performs for your capital need is the key consideration.

During their underwriting processes, acquisition financing providers analyze probable performance projections for their proposed borrowers. The underwriter often toggles between a few scenarios to sensitize the growth variables leading to slower revenue and margin growth over time. The lender’s underwriting view is usually an extension of its credit intelligence and historical experience.

Mezzanine debt loans occupy the risky echelon beneath the bank but ahead of the equity in a capital structure. They are naturally subordinated to the bank loan via an intercreditor agreement wherein the senior lender retains the power to block their interest or force them to standstill.

In the middle market, acquisition financing providers are regarded as super intelligent and hardworking. They have distinguished themselves at elite banks or consulting firms and possess the ability to synthesize voluminous levels of info into a coherent, succinct takeaway or observation. This skill is extremely valuable in attributing causation to business drivers in a financial model used to foretell the future.