Part 2 of 2
By Bob Hodgson, Investment Banker
Last week’s article described mezzanine financing. This is being continued this week with an example of how mezzanine financing is used.
Mezzanine debt often has unique features that make servicing the debt more manageable. Mezzanine lenders will occasionally include features like PIK (Payable In Kind) toggles, which allow the borrower to pay its interest by rolling it into the loan balance. Thus, if the company cannot make an interest payment as normally scheduled, it can defer some or all of the interest for a period of time. You will not find this feature with senior debt.
Here is an examples of mezzanine financing:
Let’s say Mr. Smith has a Branson business and he wants to expand his business. The lender will need warrants or options for the mezzanine loans because the loan is unsecured.
So Mr. Smith obtains a $5 million loan by showing he has an annual cash flow of $3 million. Mr. Smith unfortunately defaults because his business had a down turn in business. The lender takes a portion of his business and sells it to get back his money.
An investment banker establishes the financial parameters, prepare business and financing plans, and negotiate the terms and the structure.
Advantages of mezzanine financing:
A. Easy to obtain and does not require any asset as a mortgage
B. The structure is quite flexible. The borrower is able to obtain loans from multiple sources which results from each lender being smaller.
Disadvantages of mezzanine financing:
A. The loans are unsecured so the lenders incorporate restrictive conditions on the borrowers like warrants and options of partial ownership.
B. The interest rates are high because it is an unsecured loan.
Fast-growing companies often find that they do not need to pay the high interest rates for very long. If the company grows then its value should grow. Thus, it’s likely the company will be able to refinance the entirety of its senior and mezzanine debt into a single senior loan. The senior loan would be a lower interest rate.
You are unlikely to see this kind of debt in the public debt markets. Mezzanine debt can be found in a wide range of transactions including real estate developments.
Mezzanine loans are not to be used for start-ups or early stage companies. The minimum size for a mezzanine loan is $5 million and the average is around $10 million.
Amvest Financial Group is a leading international investment banking firm based in Kansas City representing clients with sales from $10 million to over $6 billion.