Mezzanine Debt Accordions & Acquisition Growth

Posted on: February 21st, 2023

mezzanine-debt

Most companies pursuing roll-ups seek rapid fire acquisitions with footprint expansion and revenue aggregation as twin goals. Roll-up acquirers frequently turn to mezzanine debt lenders due to their ability to underwrite complex deals with many moving parts. Mezzanine debt lenders analyze more deeply and have more direct operational experience than other lenders giving them an advantage assessing the integration risk inherent in a roll-up.

Mezzanine Debt and Acquisition Growth

Well-resourced acquirers with prior acquisition experience know how to manage integration risk to maintain the velocity of growth scale-up. One key scaling factor is the ease of capital access to fund acquisitions. Smart acquirers use acquisition facilities known as accordions to provide future capital, according to agreed-upon criteria. This gives the acquirer capital firepower and confidence in the market when competing for deals, especially in the lower middle market. Most mezzanine debt accordions allow for 100% financing of add on acquisitions if the company is in compliance with the leverage and debt service covenant, on a pro forma basis. If the company has performed above average relative to budget, and the acquisition is within agreed upon valuation parameters, the acquiring company will be able to draw on the accordion for funding.

Usually, the amount of the accordion ranges from 50% to 100% to the original funding amount, giving the company significant capital runway. The pricing of the accordion is comparable to the original loan amount as it relates to interest rate and any equity participating. Accordion facilities are a win-win for both the mezzanine debt lender and the acquiring company. The mezzanine debt lender gets the ability to provide more meaningful capital support to a company that performs, thereby building their asset base. The acquiring company gets greater scalability value from their capital provider, allowing them to build EBITDA more quickly and grow into a highly valuable platform company. While the accordion availability is not guaranteed, but earned through financial and acquisition performance, it is well worth pursuing as part of a large-scale financing structure due to its strategic value and operational flexibility.

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.