In the world of structured finance, “Mezzanine” is a form of capital which has a claim on a company’s assets and cash flow which is senior only to the common shareholders. That is, it lies between the upper and lower level. It is often utilized in conjunction with senior debt. It reduces the amount of common equity required in a business and can boost ROI.
Mezzanine is a valuable tool for management seeking to raise capital in the later phases of a company’s development and is not suited for start-up financing. Mezzanine Capital is usually either subordinated debt or preferred equity and is a hybrid form of capital with features of both debt and equity.
Filling the gap between the senior secured debt and common equity, Mezzanine has the potential to provide higher equity returns to the sponsors. It is also advantageous because the typical desired return by a mezzanine lender is 14% – 22%, according to a recent survey by Pepperdine University Private Cost of Capital Survey. This which is lower than the 24% – 30% on common equity required by PEGs, reducing the overall cost of capital for a mature company. Mezzanine Capital is provided by lenders who specialize in it as it has very distinctive characteristics.
Mezzanine is typically employed by corporations and financial sponsors to finance LBOs, recapitalizations, refinancings, and acquisitions. Typically, subordinated debt providers will lend up to a multiple of 2.5 times EBITDA or even higher, and loan terms range from 3 to 10 years. There is no limit on the amount of preferred stock that can be used.
Subordinated debt usually includes a number of special features. These include “equity participation” via warrants, success fees, or options. Together they are often referred to as “debt with equity kickers”. Equity kickers are important as they align the interests of the sub debt lender with those of the business owner. Subordinated debt also has special provisions such as “blockage period” or “fish or cut bait” provisions which permit a senior lender to prevent interest payments from being made on subordinated debt if the covenants on the senior debt have been breached.
Preferred stock also can have any number of attributes. It may be cumulative, non-cumulative, have conversion rights (to common equity) and rights to take voting control of the company under certain conditions.
When the collateral value limits the amount of senior secured debt, Mezzanine may be a viable alternative. Talk to us about your options.
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