Mezzanine financing is usually positioned between a bank loan and a seller note or equity investor on a company’s balance sheet. The different types and amounts of capital that businesses and mezzanine lenders will agree upon is very negotiable and varies depending on several key factors. Two of the most important factors in these agreements are the company’s cash flow and EBITDA. The inter-creditor agreement is the pivot point between the different loans in the capital structure. It defines what each lender or note holder can do, and is ultimately a tool to protect the company, if the business hits a rough patch. The most common form of intercreditor agreement in a mezzanine financing deal is between the mezzanine lender and the bank. The bank is always in first position and the mezzanine lender is always in second position. Both parties have to agree on the covenant levels and the actions each lender can take in the event of a default. The two most common provisions have to do with interest payments and acceleration of the loan. If the company is struggling, the intercreditor agreement blocks the interest payments to the mezzanine lender. This happens when the company’s cash flow is insufficient.
This can be beneficial for a middle market company. If a company has a weak year, it may not have the cash flow to pay the mezzanine lender’s interest. This allows the business to get back on its feet again and refresh its cash flows. Also, if a mezzanine lender is getting impatient and wants its money back, the stand still provision requires them to slow down for a period of time. This gives the company some breathing space to figure out the best way forward. The negotiation of the intercreditor agreement is never an easy task, but it is critical to protecting the downside risk of the company.
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