The Value of Mezzanine Debt Lenders as Relationships Lenders

Posted on: February 26th, 2020

Back in the old days, relationship lenders were prevalent. They tended to be local banks who took active interest in local companies and made it their business to financially support them. Relationships in lending are a powerful force and result in greater understanding for both sides. Forming the relationship involves learning and developing a knowledge base of how the company or the bank operates. Over time, the parties know each other so well, they build a comfort level which allows for latitude and flexibility in their dealings. As the banking world consolidated, this local relationship touch was lost due to the need for credit authority centralization and product line standardization. In some parts of the banking world, relationship lending is making a comeback in the community and regional bank sector.

Mezzanine debt lenders have always taken a relationship approach with their borrowers and continue to do so today. A relationship approach is one of the hallmarks of their success and allows them to make higher risk loans to lower credit quality companies. These mezzanine debt loans create high impact returns for their borrowers, as they scale their companies to larger size and greater valuations. Relationship lending allows mezzanine debt lenders to bridge informational and risk asymmetries that often stymie the growth path for middle market companies.

Knowledge as the Ballast for the Mezzanine debt lender

By adopting a relationship-based approach, as opposed to a transactional one, mezzanine debt lenders signal their openness to holistic learning about the company. Beyond the numbers, mezzanine debt lenders ask penetrating questions about profit drivers, customer acquisition and market sizing. They probe the psychology of the company as well to determine the motivation of growth and the character of the managers. This multi-directional questioning results in accumulation of a large knowledge base. This gives the mezzanine debt lender additional context and discernment on the stability quotient and growth likelihood of the company. This also prepares them for future dips or tough stretches in the business. When your lender is armed with strong knowledge, they can stay the course and hang in there for the long term.

Flexibility in Dealing with the Mezzanine Lender

Mezzanine debt lenders provide high levels of flexibility to their borrowers with whom they share strong relationships. Most mezzanine debt lenders realize that there is only one way out for repayment of their loan, and that is through the cash flow. Because the loan size is usually a multiple of EBITDA, they must be patient. This market reality undergirds the relationship approach. Without the luxury of exit options, mezzanine debt lenders are much more flexible in working with the company, than other lenders. Whether it is a covenant reset, additional capital, or strategic assistance, mezzanine debt lenders are 100% focused on supporting their borrower to achieve the growth plan.

Mezzanine Debt Lender’s Ability to Provide Add-on Capital

Because mezzanine debt lenders are focused on cash flow enterprise valuation, they think at a deeper level than other lenders about value creation. Their principal repayment in part depends on this future value creation so they are very focused on the need to achieve it. The ability to focus on the big picture of future value creation, allows the mezzanine debt lender to leverage its relationship approach and provide add on capital. This allows the mezzanine debt lender to fund the company throughout its full lifecycle of growth. This often includes a few acquisitions, some growth capital and some extra working capital. The relationship approach allows the mezzanine debt lender to remain relevant to the entire portfolio of funding needs of the borrower. This type of funding relationship is a positive outcome for both the borrower and the mezzanine debt lender.