Mezzanine capital is the portion of a company’s capital that sits between the senior debt and common equity and typically is in the form of subordinated debt. Mezzanine debt can provide flexible, longer term capital, which is less expensive and dilutive than equity.
Smart Business spoke with Jim Altman, Middle Market Pennsylvania Regional Executive at Huntington Bank, about mezzanine capital, the situations in which it can be leveraged as well as what criteria those who borrow mezzanine capital must meet in order to qualify for it.
Mezzanine capital is referred to as subordinated debt. What does this mean, and how does it affect when it is used and who uses it?
The senior debt has priority to all payments and collateral. The subordinated debt has priority before the common equity stakeholders. Mezzanine capital/subordinated debt can be used in order to fund acquisitions and as growth capital, and it also has applications in situations such as management buyouts, debt restructuring and succession planning, and can be used to leverage recapitalization.
Mezzanine capital providers are looking for certain criteria when providing this type of debt. For instance, lenders want companies with a solid, proven track record, good cash flow and solid management. Mezzanine capital is not, however, available for startups, companies that have a high exposure risk to commodities, or companies that have narrow customer concentration.
In what ways can mezzanine capital be used to as a tool to help finance an acquisition?
In an acquisition, mezzanine capital can certainly provide a portion of the capital stack. The utilization of mezzanine debt along with senior debt can provide a cost-effective solution for expansion-minded companies and provide the ability to raise less outside equity for the acquisition.
What are the potential risks or the downsides of acquiring mezzanine capital?
Borrowers may see covenants that restrict the ability for additional borrowings and refinancing, and may require quarterly or annual measurements of financial performance. In addition, spending including compensation and dividend payouts may be restricted. The cost of mezzanine capital is higher than that of senior debt.
What misconceptions are there around mezzanine capital that might mean it’s a product that goes unexplored?
The misconception certainly could be that mezzanine capital is not really a well-known product, but is certainly a viable source for companies to access capital for a variety of reasons:
- Mezzanine capital can support a company’s long-term growth and increase the value of current shareholders, and in some cases allow the owner/shareholder to receive liquidity.
- Mezzanine capital providers have the ability to continue to invest in a company to support future growth needs or assist in ownership transitions.
- Mezzanine providers are making a five-year plus investment and certainly have the ability to provide advice and support in the operation of the business over a longer time period.
Mezzanine financing can be particularly advantageous for companies that are going through ownership transition, recapitalization, internal aggressive growth or an acquisition growth strategy
This type of financing is just another arrow in a borrower’s finance quiver. For those who haven’t heard of mezzanine capital or who aren’t aware of the ways in which it can be used, it’s certainly a product that is worth exploring.
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