Mezzanine Debt Bare Necessities

Posted on: October 19th, 2023

mezzanine-debt

Ambitious acquirers and business founders realize early on that banks rarely step up when needed. This reality caused the rise of mezzanine debt lenders as direct providers of capital to companies. The business case for mezzanine debt is strong. Larger loan tickets, longer maturities and flexible repayment is compelling for growth companies.

Additionally, the ability to customize the loan structure to fit immediate and future needs of the borrower is a huge advantage over other loans and can produce a continuous stream of capital fuel for a borrower. While many seek mezzanine debt, few are qualified to uptake it due to an unfortunate lack of preparedness. There are a number of bare necessities that need to be in place for a mezzanine debt lender to seriously consider your loan request.

Firstly, companies must have reviewed or audited financial statements, or a quality of earnings review from a respected external accounting firm. Many companies skate by with quick books, underinvesting in their accounting personnel and systems. Mezzanine debt lenders need to see strong accounting systems and a good accounting department. Secondly, mezzanine debt lenders need to see a clear and compelling growth plan be it an acquisition, new product innovation or new market launch. They are comfortable with all types of scale-ups to the extent the growth is an extension of the core business.

Thirdly, the loan amount needs to be a minimum ticket size of $6 to $7 million for middle market viability. This usually translates to a revenue minimum of $10 to $15 million and an EBITDA minimum of $2 to $3 million. Finally, the Company needs to have a favorable historical earnings trend signifying stable underlying market demand. Companies that have cyclical boom-bust earnings trends or recent hockey stick growth are generally too volatile. These elements are the bare necessities of a mezzanine debt raise as well as sound management approach.

As new acquisition financing credit funds pivot to non-private equity sponsored deals, many lack experience with the asset class. Non-sponsored deals such as direct loans to companies or loans to independent sponsors making acquisitions are quite different from private equity backed deals and require a different thought process and engagement style from the lender.

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.