Mezzanine Debt

Today’s economy has put many private companies in a tight spot.  Companies end up with too much bank debt as business volume and profits contract.  But lower earnings mean that company owners who would have been ready to sell their companies now can’t do it because they end up with too little after paying off their banks.

So, how can you reduce your bank debt, improve your cash flow, and stay tough while you wait for the outside economy and your earnings to recover?  One answer is mezzanine debt.

Mezza-what?  Mezzanine debt gets the name because it’s half way between senior bank debt and equity.  Because it’s kind of both, it serves really well in the right situation.  Mezzanine is semi-permanent capital, like equity, so the company does not have to make monthly or quarterly payments of principal.  It usually has a 5 to 7 year term. Read the rest of this entry »

It comes as no surprise that some early stage companies get started with a bang because they are flush with capital from family, friends and early stage angel investors.  The excitement is palpable when some of this money has created “buzz” – articles in major newspapers and technical blogs, or TV coverage – all expounding on their products or services and how they will change our world.  By now, the management team, punch drunk on the good publicity, is convinced they are on the right track and expect the phones to ring off the hook from venture capitalists and other investors all clamoring for a piece of the action.  A major hiring and spending spree ensues, driven by the belief that outsized growth is quickly going to take over.  Forecasts and valuations are revised upwards to account for the fresh new optimism.  Concepts like “managing cash burn” and “increasing revenue traction” are fleetingly discussed at team meetings or around the water cooler in this “anything is possible” environment.

Reality Sets In

In 1999 or early 2000 at the height of the dot-com boom, this scenario may have ended with a happy outcome.  Venture Capitalists, having read all the publicity and anxious to get on the train, fund a Series A round based on generous pre-money valuations, little to no due-diligence and guidance that the money is to be used to expand hiring and spending at an even greater rate.  That was then – now we are in a different world. Read the rest of this entry »

In the current market, we are faced with companies and governments requiring the expansion or renovation of their capital intensive assets in various related infrastructure market segments.  Whether expanding manufacturing facilities, implementing new infrastructure capacity or leveraging existing assets for expansion into different regions or market niches, innovative financing is often at the core of long-term projects to transform a company’s strategy.  The ability to transform and execute upon one’s corporate strategy in capital intensive industries (like energy, oil & gas, transportation, government concessions and/or heavy equipment and manufacturing) is dependent upon the access to capital required to deploy existing and new capital assets that are critical to the long term recurring cash flows of a company’s or project sponsor’s(s) operations.

Akin to the underlying transformation in corporate objectives, the challenge with the project finance strategy is that the investment is made upfront while the anticipated benefits of the initiative are realized in the much longer term.  It is imperative to identify and prequalify sources of funds that can thoroughly understand the underlying changes being implemented by the prospective borrower(s) and project sponsor(s), and to achieve a comfort with the future cash flows arising from the collateral package of project investment or captive acquisition. Read the rest of this entry »

If You Want Funding This Year

Several CFO’s have recently asked me “When will the capital markets “return to normal?”  My answer is:  Not this year.  Therefore, if you are a C-level executive that wants to obtain funding for your company, you might consider leveraging your company’s top-line gross revenues with a new form of financing structure from Entrex, Inc., based in Chicago, and Bank of New York/Mellon, and made available to you through your corporate finance investment banker.

The current reality is that talk by traditional banks about low interest rates is not solving your cash flow needs, particularly when stricter lending requirements have reduced the amount of your working capital line or term loan.  Also, selling or giving up equity at a today’s reduced valuations is not attractive, which explains why raising equity capital in the types of private placements typical a few years ago, are not getting done.  As a result, unless your company is distressed (and, therefore, attractive to vulture investors), then you are most likely frustrated with your inability to access capital for growth and recapitalizations.

One attractive and innovative financing solution that middle market companies might consider is obtaining lump sum capital in exchange for giving the investor a monthly fixed percentage Read the rest of this entry »

As of January 2009, many banks and non-bank lenders are caught in a ‘liquidity trap’ where they must fix their own balance sheets before they can resume lending to customers. Getting buyout financing is harder than ever and new loans are secured by both cash flow and hard assets. On Wall Street, there’s a big slowdown in mergers & acquisitions.

Wall Street’s train wreck is Main Street’s opportunity.  Smart business owners and their advisors will certainly use these changes to their advantage.  Here are some ideas for owners considering a capital transaction in 2009:

1. Cash is king. Instead of an illiquid investment in a private company, this is probably a good year to have cash.  Consider a buyout or recap if you have another use for money. There are many opportunities in financial investments and real estate, for example.
2. Debt is cheap. For borrowers that qualify, interest rates are as low as they have been in a lifetime.  If you have good credit and debt-free assets, consider recapitalizing with low-cost debt.  Ask for an estimate of your secured debt capacity. Read the rest of this entry »

With all the news about the difficulties the Big Three auto executives had in securing financing from the U.S. government, it is good to know that middle-market business owners do not need an Act of Congress to get funded. However, you can be assured if you are looking for financing in today’s market — every aspect of your business will be examined in detail, including your business plan.

Even with a great product or service and a long list of customers your business may not receive the desired funding. Prospective investors receive so many business plans each year that weeding through them with only a cursory review has become a standard practice.  In order to ensure your business plan gets read by investors, it will need to stand out. From the investor’s point of view, some of the more common problems with a business plan include the following:

Unrealistic Claims About Competition or Risk

Everyone has competitors, so to claim that you have no competition will almost certainly cause investors to conclude that you do not have a firm grasp of the market. The “Competition” section of your business plan is your opportunity Read the rest of this entry »

During the last period of economic boom many companies expanded through debt financing. The logic was if one machine is making money then adding three machines will make three times the money. As long as the economy was strong and margins remained high this was viewed as good thinking. After all, even if the economy dropped, the value of the equipment, even leveraged, would be equity that could be used to raise capital in a downturn.

Then just like the housing market, the phrase “mark to market” enters the valuation. Suddenly you find you’re upside down in the market. Whether you borrowed money to expand your organization, equipment, or inventory; all have suddenly become less valuable in a down economy. The true value of the equipment is the value of the goods produced by the equipment, not the intrinsic value of the equipment itself. The inventory values have declined. There is too much equipment on the market at the same time and suddenly the value of your asset has been cut in half. Your people are being paid a premium especially when compared to foreign markets but they are refusing to go along with your cost cutting measures.

The dictionary defines under-capitalization as follows:”A business has insufficient capital to carry out Read the rest of this entry »

Down economic cycles can offer excellent buying opportunities for well positioned companies but they may create funding challenges to getting a deal closed.  When credit is easy and senior debt lenders are liberal with leverage and terms, most buyers don’t need additional help in funding their deals.  In a down economy, it’s quite a different matter and mezzanine financing may be the solution.

Mezzanine financing is also known as subordinated debt and is junior to the security interest of senior debt while ahead of equity stakeholder rights.  Many of the features of a mezzanine loan are similar to a bank loan.  There will be provisions for interest payments, an origination fee, amortization terms, covenants, potential liens, default definition and remedies, and other items.  Additionally, mezzanine investors craft warrants into their structures to compensate for their risk as junior lenders.  Warrants provide the right to purchase equity at a later date.  Don’t worry, mezzanine investors don’t want to own your company so they will include “put” options, which when exercised, require the borrower’s company to buy-back the stock at a pre-determined price often tied to a valuation formula based on a multiple of the company’s earnings.  In short, it’s an in and out transaction designed to augment their return. Read the rest of this entry »