Why Mezzanine Debt is the More Flexible Growth Capital Alternative.

Posted on: February 20th, 2020

The words growth and debt appear oxymoronic, and somewhat baffling to companies seeking to fund their growth scale-up. Debt has a bit of an onerous and rigid connotation, something that requires steady cash flow discipline and maintenance. Growth is an inspiring word that conjures the power of newness and transformation. Mezzanine debt bridges both concepts of growth and debt to provide a transformative form of flexible capital. Mezzanine debt utilization provides a level of financial flexibility to borrowers unmatched by other forms of growth capital. This flexibility is best seen through how mezzanine lenders envision your loan capacity, your EBITDA and repayment scenarios.

How Mezzanine Debt Loan Capacity is Envisioned?

Mezzanine debt is viewed through the prism of cash flow, and the borrower is viewed as a going concern with an enterprise value consisting of a multiple of its cash flow. Mezzanine debt lenders have a very flexible approach to setting the multiple which works to the benefit of the borrower who needs to get a deal done. Mezzanine debt lenders use the same valuation rubrics as private equity investors which value businesses based on a multiple of their adjusted EBITDA. Each mezzanine debt deal has its own specially determined structure, with customized multiples determined by the lender for each deal as well. Senior debt is usually up to 2.5 to 3.5 times EBITDA. The mezzanine debt layer usually goes from 3.0 to 4.5 times EBITDA.

The lenders consider myriad factors including different industry, financial and business model variables to arrive at a bespoke mezzanine debt loan capacity for each deal. It is a highly subjective process. A lot depends on their view of the quality of the management and their feel for the business. Most mezzanine lenders will not turn down your loan request because you are asking for more money than they can lend. They are more likely to adjust their pricing and/or suggest more equity come into the deal. Because they look only at cash flow, they set can set very favorable debt capacity multiples.

How Mezzanine Debt EBITDA is calculated?

Mezzanine lenders allow prospective borrowers to use one-time adjustments as addbacks when arriving at their historical EBITDA. This means they allow flexible use of EBITDA, which is a gamechanger when calculating your debt capacity. Each extra $1 of adjustments means 3 to 4 times more mezzanine debt loan capacity. This incremental mezzanine debt capacity is quite valuable to a borrower who is funding a transformational growth plan. Mezzanine lenders also allow you to use higher levels of EBITDA to unlock future tranches of mezzanine debt, as you scale up. This give you future capital to deploy as part of your scale-up.

How Mezzanine Debt Lenders Envision Loan Repayment?

Most bank lenders must have two ways to get their principal back, usually through sale of the collateral or through a personal guarantee. This constant collateralization requirement constrains the amount a company can borrow under this scenario. On the other hand, mezzanine debt lenders are not collateral focused at all, but focused on the mid term to long term cash flow growth for principal repayment. This is a much more flexible way of establishing repayment and gives the borrower a multi-year growth runway to make investments before they must concern themselves with repayment. Through having more relaxed and flexible repayment options, growth companies have more cash flow and time to scale up.