What Are The Common Mezzanine Terms?
Posted on: September 19th, 2014
Mezzanine financings tend to be highly negotiated transactions, and are often customized to suit a particular situation. While this is a major advantage, it is important that the borrower have a broad understanding of the most commonly used mezzanine terms.
Generally, the more heavily negotiated mezzanine terms are those relating to:
Type of instrument
Most mezzanine financings typically consist of unsecured or second lien debt. In most cases, an issuer may prefer one or the other depending on its capital structure or tax and accounting considerations.
The lender may also base their preferences on their investment guidelines or their assessment of the potential investment’s risk profile.
The maturity period of mezzanine debt is generally five years or longer. However, the maturity for a particular issue often depends on the scheduled maturities of other debt in an issuer’s capital structure.
When mezzanine debt is incurred at the same time as senior bank debt (for example, during an acquisition or buyout), senior lenders often insist that the mezzanine debt mature later than the bank facility.
As far as interest rates are concerned, various permutations are used within mezzanine transactions to accommodate the needs of the specific issuer and investors. Generally most mezzanine debt instruments feature a cash coupon with a fixed rate, which is paid monthly.
There is often a deferred interest amount as well which accrues over time.
Ranking in the capital structure
The term ‘ranking’ refers to the position of the mezzanine debt in the issuer’s capital structure. Senior lenders are always in front of the mezzanine lender and the mezzanine lender is in second position.
There is an inter-creditor agreement between the senior lender and the mezzanine lender that governs what happens if the company is unable to meet its debt service coverage ratios.
Generally, mezzanine debt is unsecured, especially in larger financings. However, in the few cases when mezzanine debt is secured (generally middle market issuers); the lien is then typically junior to the lien securing the issuer’s senior credit facility.
Often the mezzanine lender will request a second lien on the assets and a pledge of the stock of the company.
The covenant set consists of a minimum EBITDA test as well as a debt service coverage ratio and a leverage multiple. The covenants are usually set at a 20% discount to the expected budget performance.
Most mezzanine lenders are comfortable with a debt service coverage ratio of 1.15 to 1 and a leverage multiple of 3.5 times for lower middle market size deals.
Very often, in a mezzanine deal, investors seek to enhance their returns by negotiating for equity participation alongside their debt investments.
Equity investments may take on various forms including, warrants or options to purchase a specified percentage of equity (often 1% to 5%), a right to co-invest in the issuer alongside the controlling stockholder/ private equity sponsor or a conversion feature that allows mezzanine investors to convert all or a portion of their principal investment into common equity.
Traditionally, mezzanine loans in the US have always been buy-and-hold assets. The individual mezzanine loans are usually transferable to another lender and can be sold as a single loan to another lender or as part of the sale of a portfolio.
Attract Capital has 20+ years of experience in helping private companies access mezzanine funding directly from mezzanine lenders. Contact us today to speak to one of our advisers.
We will be happy to provide a free consultation regarding your mezzanine financing needs.