Mezzanine Debt Fortune Favors the Prepared

Posted on: September 22nd, 2023

mezzanine-debt

In the mezzanine debt arena, fortune favors the prepared borrower. Unlike other loans which require only form filling, mezzanine debt requires borrowers to have certain things in place before the process even starts. It requires a high level of intelligence and sophistication as to information standards, presentation frameworks and diligence responsiveness. The borrower needs to take stock of their internal readiness to simultaneously handle a multitude of information requests. Mezzanine debt lenders assess financial performance as well as operational strength and market growth potential. This multi-faceted level of scrutiny requires preparation across the whole enterprise and often requires developing new materials and ways of articulating things. The mezzanine debt screen in part tests for resource depth to ensure the Company has sufficient management bandwidth. To conduct a successful mezzanine debt, raise process, a borrower should review the following areas and make sure they are up to standard.

High Quality Financial Statements – mezzanine debt lenders need either reviewed or audited statements as well as high quality monthly financial statements to assess the underlying performance of the business. If your numbers are a bit shaky, they should be cleaned up before advancing with the process.
Deep Bench of Management – middle market companies need a professional team beyond a charismatic founder to be mezzanine debt worthy. Testing for organizational strength and resilience is a key underwriting consideration for the lender.
Growth Story – all companies need a narrative structure to hook the mezzanine debt lender on their future growth. It is not enough to describe what the company currently does. There should be a clear and compelling story as to how the growth will unfold, preferably as an extension of the core business.
Strong current performance trend – the best time to raise mezzanine debt is when the business trend is positive. Overperformance reinforces the foundations of your growth story and makes future growth highly credible.
Professional Presentation – Companies need to explain their specialization in a sophisticated manner. This articulation should go beyond the basics and describe the Company through conceptual business model frameworks.
Internal Firepower and Desire – A mezzanine debt process is demanding and requires a lot of manpower. All senior management need to buy into the process to ensure a successful closing.

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.