Mezzanine versus Equity Investors
October 11, 2022
by a searcher from California State Polytechnic University - Pomona in Pomona, CA, USA
What are the advantages and disadvantages of Mezzanine debt versus Equity Investors in completing a Capital Stack and filling Gap Equity?
As a self funded searcher I am working through the structure of each and in modelling it seems like the Mezzanine would provide greater equity for the searcher and greater returns. So why not focus on that structure?
Am I missing something here? Seems like most interest I see on posts are for equity investors to fill the gap.
from University of Notre Dame in Dublin, OH, USA
If you increase the debt-to-equity mix in your cap stack, this will increase returns to equity.
But, there are tradeoffs.
First, is the availability of capital. Most traditional mezz lenders (i.e., SBICs) will look for a minimum of $2mm in EBITDA, though some will dip down into the $1-2mm range in certain situations.
Second, is flexibility. While less restrictive than conventional bank debt, mezz lenders will be more restrictive than equity. Notably, mezz lenders will require maintenance covenants; a typical covenant package will include a leverage covenant (debt to equity) and an FCCR covenant ("fixed charge coverage ratio" covenant, usually something like (EBITDA-Capex) / (Principal + Interest)). They might also include max capex or other covenants.
Third, is alignment of incentives. In downside scenario, a mezz lender could exercise their rights & remedies, potentially pushing you (and your equity investors) out of the deal. In a more middling scenario, they could also prioritize getting their debt repaid over the growth of the business, and thus prevent you from pursuing growth opportunities (that would benefit equity investors).
Happy to discuss further if helpful.
from College of William and Mary in Stamford, CT, USA