The Warrant Component of a Mezzanine Loan – Generally, mezzanine lenders are not looking to be long-term stockholders, but rather to achieve a target rate of return. Nevertheless, returns linked to share price appreciation take on a small yet vital role in mezzanine activity. This is because mezzanine investors regularly seek to enhance their interest rate returns by negotiating for warrant upside alongside their debt investments. Mezzanine warrant returns, sometimes referred to as an “equity kickers”, usually take one of the following forms,
- A warrant which equates to between 1% and 5% of an issuer’s share value. The lender does not own shares but rather the right to the return equal to that percentage of the shares. To generate cash from their warrant, they have the right to put the warrant to the issuer at some pre-determined date based on a pre-determined formula.
- A right to co-invest in the issuer as a private equity sponsor or alongside the controlling stockholder. Typically, the co-investment is at the same price as the controlling stockholder’s or sponsor’s investment and the purchased equity will be bound by the terms of the stockholders’ agreement or byany other arrangements made among the stockholders.
The warrant- a key issue in mezzanine financing
Since the overall return to the mezzanine lender includes the investor’s ability to realize the value of its warrant, a viable exit strategy is necessary. Generally, the exit events include the sale of the issuer, a recapitalization, or a refinancing. Most commonly, the issuer will grow rapidly after the mezzanine funding and will able to attract a bank loan to take out the mezzanine loan and the warrants.
The terms of warrant are negotiated. The lender usually has tag along rights and pre-emptive rights as well as anti-dilution protection. The warrant while detachable, is rarely sold on its own. The lender is usually very collaborative with the issuer in terms of ensuring a liquidity event to take out the value of the warrant. The warrant value is determined by the success of the company’s growth and its exit. For companies with strong growth, the value of the underlying shares will increase thereby increasing the value of the warrant. For companies with no growth or decline, there is little if any value in the warrants.
Whatever be the case, the warrant return is a key issue in mezzanine financing that needs to be dealt with by an expert financial advisor with an excellent track record in negotiating successful mezzanine deals.
Attract Capital has a wealth of experience dealing with warrant issues. The firm has a platform of over 100 mezzanine lenders that can provide quick sourcing of mezzanine capital.
Contact us now to set up a free consultation with our expert financial advisors.
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