Mezzanine Debt & Deal Sizes

Posted on: May 26th, 2021

mezzanine debt

Entrepreneurs take a liking to mezzanine debt, once they understand what it can do for them. It is a non-dilutive form of unsecured debt that is based on cash flow growth of the business. The applications for lower end sized companies are quite compelling especially in large industries that have many small mom & pops owned business.

Once a visionary entrepreneur learns how it works, they usually come up with several acquisition scenarios. While their instinct is spot on to deploy mezzanine debt, often their required loan size falls well below the minimum loan size level. Usually, this realization occurs after the deal sponsor has spent time and money on landing a deal and is trying to bring in the financing.

Mezzanine Debt Lenders in Middle Market

Given the lack of market indices for private debt, it is important for deal sponsors and businesses to know the ticket sizes available in the market before they commit to a deal. Most middle market mezzanine lenders have a loan size as well as a company size criterion. The loan size is usually a minimum of $6 to $8 million. Company size is expressed in terms of revenue and EBITDA. The revenue size threshold $10 to $15 million. The EBITDA threshold is $2 to $3 million.

Mezzanine funds occasionally will do a smaller deal, if there is a compelling reason such as industry familiarity or a high level of upside. The fixed nature of the work involved to close a mezzanine loan necessitates the focus on larger deals. It takes the same amount of time and effort, if not more, to close a small deal than a larger deal. In addition, smaller companies are considered riskier credits than larger, more established platform companies that may require $10 to $15 million in financing.

While there are some small business-oriented mezzanine funds, most of the lower end middle market funds are SBIC-based mezzanine debt funds. These funds manage anywhere from $150 million to $400 million across one or several funds, and as a result need to focus on deals with some mass, so they can obtain operating leverage, risk mitigation and diversification. While we see a great number of high-quality deals below the $2 million minimum, it pays to meet the market in its sweet spot of size to maximize your ability to attract mezzanine debt financing.

The deal world thrives on the belief that the institution providing acquisition financing will deliver on their promise. Lenders usually telegraph their capital capabilities early on during the sales pitch and give their deal sizes and hold levels for their fund.

Most mezzanine debt borrowers are rightly focused on the downside of breaking a covenant and for good reason. Most borrowers have had to deal with overly sensitive banks in the past which often exhibit trigger happy default notices during covenant breakages, especially when they want to get out of a loan.

Buried within the pedigreed bios of mezzanine debt lenders and private equity investors lies a secret plainly obvious to any average joe. While mezzanine debt lenders have strong educational and work backgrounds from large elite institutions, they usually lack real world experience of the kind that is valuable to understanding the businesses they seek to evaluate.