Posted on: February 20th, 2015
The middle market can be divided into three distinct segments- lower middle market, core middle market and upper middle market. Companies with EBITDA below $10 million are generally classified as lower middle market. They are typically family or entrepreneur owned where individual customer wins and losses can greatly impact the company’s performance. The core middle market comprises of companies, which fall within $10 to $75 million of EBITDA and companies that fall in the above $75 million bracket of EBITDA or more are generally termed as upper middle market. They are most often publicly held or sponsor backed.
The importance of mezzanine debt for lower middle market companies
Lower middle market companies generally get their financial funding from local banking sources. However, very often when a growth opportunity or an acquisition deal presents itself, such companies often find a shortage of local capital sources. While senior debt may be difficult to obtain, opting for equity capital does not always present a favorable alternative. It is challenge for lower middle market companies to access government-sponsored entities such as Small Business Investment Companies (SBICs) or public entities such as Business Development Corporations (BDCs), due to their qualification requirements. In such situations, mezzanine debt, can prove to be the best choice for a lower middle market company.
Mezzanine loans come with the advantage of requiring no principal payments and only interest payments for the first 3 to 4 years. Furthermore, mezzanine loan structures are extremely flexible with the loan maturing in 5-7 years. Mezzanine providers generally provide mezzanine debt on an EBITDA multiple basis- the standard mezzanine debt multiple being 3.5 times EBITDA. The typical interest rate charged is approximately 12% per annum. The lender also receives additional return upside based on the future growth of the business. The amount of funding coupled with the low cost and structural flexibility, makes this a suitable option for a lower middle market company with a strong cash flow.