Stringent disclosure requirements and
rising interest rates have many businesses looking for alternatives to traditional securities and bank loan funding
options. Mezzanine financing is helping fill
the gap, especially for transactions under
$50 million. Buyout and mezzanine funds
raised $102.9 billion in 2006, their highest
year ever, according to tracking firm
Thomson Venture Economics.
Mezzanine financing offers more flexibility than bank loans and has less regulation
than securities. These advantages come at
a price, including the possible transfer of
some equity.
Smart Business spoke with Mike Revord
of mezzanine investment firm Aldine
Capital Partners to learn about mezzanine
financing and when it is a good option for
businesses. Aldine Capital has partnered
with MB Financial Bank to provide mezza-nine financing to its middle-market customers.
What sets mezzanine financing apart from
other capital options?
It’s really a hybrid between debt and equity financing. There is debt — the company
issues a note with a coupon, but the
investor typically wants to take an equity
position or some other form of upside. It’s
a great source of low-cost capital when
compared to common equity.
Mezzanine financing is almost always
used with a bank loan and is typically used
in leveraged buyouts or any other type of
ownership change where the amount of
debt the company needs to take on is more
than it can get a bank loan for. Banks typically will lend a company two to three
times its Earnings Before Interest, Taxes,
Depreciation and Amortization (EBITDA),
while mezzanine can go for three to four-and-a-half times EBITDA, sometimes even
higher, depending on the business.
What types and sizes of businesses are suited for mezzanine financing?
Companies with less than $10 million in
sales and less than $1.5 million in EBITDA
are less attractive to mezzanine lenders,
and once deal sizes get into the $60 million range and higher, mezzanine tends to be
more like a private placement. Company
type is more important. There are several
types of businesses where mezzanine
financing doesn’t work well, such as fad
companies or those in very cyclical industries. Fad companies include toy companies and software companies where the
product might be very hot for a short time.
Highly seasonal and cyclical businesses
don’t appeal to mezzanine finance companies because of the requirement for a consistent earnings performance. In fact, to get
mezzanine financing, a company has to
show consistent performance for a fairly
long time, usually at least three years.
What are some key terms and negotiating
points?
One thing that is commonly misconstrued in mezzanine financing is the role
the coupon rate plays in the cost of capital.
In deals where warrants are included, the
coupon is not the only cost to the borrower. Warrants are typically for common
stock and dilute the borrower’s ownership
in the company. It’s important to understand the overall yield. I recommend that
companies focus on the overall cost of
their capital, not just the coupon rate.
The coupon rate is negotiable, and so is
the length of the deal and other terms.
Mezzanine deals are typically no shorter
than five years, and five to eight years is
standard. The investor looks at it as a long-term opportunity.
How does the financing process compare to
traditional bank loans?
There are many similarities, and a few
differences, with the commercial lending
process. The timing of the processes is
very similar. So is a lot of the information
the lenders want, but that’s where bank
and mezzanine financing start to diverge.
Mezzanine financiers tend to look more
long term than banks. They’ll look more at
the company’s value-creation capabilities
and more in depth at the market and the
competition. They’ll also spend more time
on strategic and board-level issues. In that
regard, they’re more like a buyer than a
lender. After the deal is complete, the mezzanine financier won’t be involved in the
day-to-day operations but will have board-level involvement, which can continue for
years.
Mezzanine financing is a lower-cost
source of capital than issuing equity but is
more expensive than borrowing from a
bank. Mezzanine is more patient than a
bank because it doesn’t demand regular
principal payments.
Mezzanine financing is a young market,
and it’s maturing quickly. There’s a lot more
competition than there used to be, which
has made more capital available. It’s also
led to the development of a more standardized approach for getting mezzanine
financing, which is another positive development for borrowers.
MIKE REVORD is managing partner of mezzanine investment
firm Aldine Capital Partners. Reach him at (312) 346-3950 or
[email protected].
