The Direct Lending Impact of Mezzanine Debt Lender

Posted on: January 10th, 2022

mezzanine-debt

Mezzanine debt lenders have a low profile and are known for their functional role in leveraged buyout structures. To many private equity sponsors, they are a layer of debt that plugs a capital hole. Many mezzanine debt lenders are exclusively focused on private equity type deals, particularly larger funds of an asset under management fee pedigree.

Mezzanine debt lenders also play a less heralded but highly impactful role pollinating the growth capital and acquisition capital needs of middle market companies, outside of any private equity involvement. In this direct lender role, they work directly with borrowers to fund acquisitions, organizational scale-ups, and new product and market launches. This form of direct lending is akin to venture capital for established companies allowing them to grow at rapid rate, previously unachievable under their old capital structure.

Through this funding approach, companies strategically invest over the long-term horizon leading to innovation and scale thereby creating economic growth for all to participate in. In this type of arrangement, the mezzanine debt capital is not used to transfer ownership from one party to another as in a private equity deal. It is used as fuel to increase the size of the company through adding employees, locations, and new systems, all of which creates a ripple effect in the economy.

Role of Mezzanine Debt Lenders

Through lending directly to companies, mezzanine debt lenders take on the role of innovation capitalists without the expense associated with a venture capital investor who usually ends up owning a large percentage of the equity. Existing ownership has complete control with respect to governance and day to day management. This type of lending is practiced by an increasing number of mezzanine debt lenders, particularly those with operating backgrounds. Direct lending allows middle market companies to continue to grow unimpeded by capital constraints and become true leaders in their respective industries.

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.

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.