8 Uses for Mezzanine Financing

02.12.18

 

Mezzanine financing serves as a means to an end.

For many companies, mezzanine is not used as permanent capital, but instead used as solution-oriented capital that performs a specific purpose, and can later be replaced with a more conservative type of financing.

Mezzanine financing is a form of junior capital that sits between senior debt financing and equity, and is a source of capital companies can access beyond what they're otherwise able to achieve on a senior basis. Mezzanine financing is more expensive than senior debt but cheaper than equity. It is also the last stop along the capital structure where owners can raise substantial amounts of liquidity without selling a large stake in their company.

Companies can turn to mezzanine financing instead of, or in addition to, other types of capital to obtain the funds they need to accomplish their goals. Mezzanine can be a useful addition to a company's balance sheet because it is a patient source of financing that is interest-only, with no required amortization payments before maturity.

During the life of the mezzanine financing commitment, a company has time to recover from the significant 'event' that drove the initial financing need – be it an acquisition, shareholder activity, growth financing, or some other capital need – building up senior debt capacity to refinance the mezzanine at or before its maturity.
 

Mezzanine provides incremental leverage to facilitate a wide variety of transactions. Here are 8 uses for mezzanine financing:

1. Recapitalizations

Recapitalizations involve raising new capital to restructure the debt and equity mixture on a company’s balance sheet, and are an ideal use case for mezzanine financing, especially when owners want to both achieve partial liquidity and maintain control of their business. For example, mezzanine financing can be used in situations where a group of shareholders are seeking partial or full liquidity, while other shareholders seek to remain actively involved in the business.

It is common for a private equity firm to provide capital in exchange for majority or complete ownership of a company in situations where mezzanine combined with structured or minority equity can be used instead, particularly if the existing owners are not seeking full liquidity and an exit from their business. Rather than pursuing a new majority equity owner and  giving up control, companies may look to a mezzanine-supported 'minority recapitalization,' as an attractive alternative.

Example: HH Global had decided to complete a minority recapitalization, and planned to use the capital received to provide partial shareholder liquidity, including full liquidity for a retiring shareholder, fuel their organic growth opportunities and fund potential acquisitions. Most importantly, the minority recapitalization would enable providing greater ownership to the extended leadership team, who will be driving the business forward. To facilitate the minority recapitalization, Prudential Capital Group provided HH Global with mezzanine financing as well as senior debt and senior accordion notes, partnering with the company’s existing bank, which will continue to provide working capital financing. In the end, the company was able to achieve its liquidity goal, while allowing the current leadership group to increase their ownership stake and position the capital structure with the capacity to continue capitalizing on organic and inorganic growth opportunities.

 

2. Leveraged Buyouts

In a leveraged buyout, mezzanine financing is often used by the purchasing shareholders, such as a private equity fund or other institutional group, to maximize their available borrowing capacity at the time of the purchase. Leveraged buyouts are typically completed by companies looking to raise large amounts of capital to support an ownership transition or significant growth event.

Example: Huntington Foam was looking for a financial partner to support the next phase of their growth, and determined the capital could best be obtained by executing a leveraged buyout. Huntington Foam was then introduced by Prudential Capital Group to a potential equity partner, Mill Point Capital, to help complete the financing package. When the buyout concluded, Huntington Foam received mezzanine financing and senior debt from Prudential Capital Group as well as equity from Mill Point Capital. Ultimately, the company sourced the capital they needed to pursue their ambitious, long-term growth objectives.

 

"Mezzanine financing is typically used by the current management team of a company to buy out the current owners, such as private equity or other investors, and gain control of the business."

 

3. Management Buyouts

In relation to management buyouts, mezzanine financing is typically used by the current management team of a company to buy out the current owners, such as private equity or other investors, and gain control of the business. Therefore, this allows the management team to determine the direction of the company, grow the business, and benefit from future equity value creation.

Example: The institutional investor that had majority ownership of Comm-Works decided to launch a formal sale process to realize its investment after an eight-year holding period. Excited by the opportunity to continue to grow the business, the existing Comm-Works management team negotiated a purchase offer and approached the market via SPP Capital Partners; they were seeking a combination of debt and equity financing to support a management-led buyout. The management team obtained a senior revolving credit facility, senior term loan, senior subordinated notes and preferred equity, from one lender, to supplement their equity contribution in support of the acquisition. The financing package also enabled the management team to significantly increase its ownership position and establish majority control of Comm-Works.

 

4. Growth Capital

Using mezzanine financing for growth capital could help companies achieve their goals for organic growth, such as a significant capital expenditures, or constructing a large quantity of facilities. Growth capital can also be used to enter new markets by developing new products and/or subsidiaries.

Example: Interface was seeking growth capital to help facilitate their strategic organic growth and expansion. The company ultimately received mezzanine financing as well as preferred equity, in addition to a newly syndicated bank facility. With the necessary capital now available to Interface, the company can continue to deliver industry-leading organic growth.

 

5. Acquisitions

Mezzanine financing can serve as financing for acquisitions, where companies purchase other businesses with the goal of growing and responding to customers’ needs more quickly. Through acquisitions, companies can also access adjacent markets as well as diversify their customer base.

Example: KeHE Distributors, LLC was presented with the opportunity to make a transformative acquisition of one of its largest competitors in the natural and organic food space. To accomplish this acquisition, KeHE needed an amount of junior capital that exceeded the abilities of most middle-market mezzanine investors. The company found a mezzanine financing provider that had the appropriate capital and appetite for the deal. In the end, KeHE received $80 million junior capital, $60 of which was mezzanine financing, and were able to make a successful purchase offer.

 

"Shareholder buyouts can be especially appealing to family-owned businesses who want to repurchase shares that may have fallen out of the hands of the family."

 

6. Shareholder Buyouts

Shareholder buyouts, can be especially appealing to family-owned businesses who want to repurchase shares that may have fallen out of the hands of the family in order increase their ownership stake; these transactions are often accomplished utilizing mezzanine financing.

Example: After having completed a sizeable acquisition of another bottling facility, Polar Corp., a fourth-generation, family-owned business faced a new challenge – recapitalizing the balance sheet so that it could buy out a minority shareholder and subordinated debt lender who had reached its intended investment time horizon. Polar utilized mezzanine financing and preferred equity, along with a senior credit facility to buy out the shareholder, greatly increasing their ownership stake.

 

7. Refinancings

Refinancings are commonly done using mezzanine financing to pay off or replace existing debt to take advantage of lower interest rates and/or better terms. Refinancings using mezzanine financing add flexibility to a company’s debt capital structure, better preparing them to seize opportunities like acquisitions and shareholder buyouts.

Example: Century Gaming was looking to establish a set of capital providers that could support the business as it continues to grow. The company’s management team largely wanted to refinance existing debt. Century Gaming ultimately obtained mezzanine financing in combination with a senior credit facility to replace the debt they currently had on the books. Adding a patient layer of mezzanine financing will support the growth of Century Gaming for the long term.

 

8. Balance Sheet Restructurings

Due to its patient nature, mezzanine financing is also well-suited for balance sheet restructurings. Thus, adding mezzanine financing to a company's balance sheet can optimize their debt capital structure, helping to fulfill debt requirements for transactions such as acquisitions and management buyouts, while giving the company time to recover from those expenses. It can also satisfy a senior lender’s requirement for a junior capital raise, or create additional senior debt capacity for a business. A balance sheet restructuring can be done in combination with a larger transaction such as a full refinancing of the debt capital structure, or a growth event for the business; it can also be done as a standalone transaction.

Example: ARCA had planned to acquire CTS Group, an Italian provider of cash recyclers and check scanners, but was challenged by an inability to secure a proper cross-border financing package that would fulfill acquisition debt needs as well as the structuring requirements of the prospective Italian sellers. ARCA proceeded to secure mezzanine financing as well as senior debt and a revolving credit facility, allowing the company to meet the requirements of CTS Group’s sellers and complete the acquisition, better positioning them up to achieve their long-term strategic goals.

 

There are many uses for mezzanine financing, as its patient, solution-oriented qualities make it an ideal capital resource for companies that need capital beyond senior debt in order to fulfill an immediate need that supports the lasting success of the business.

 

Interested? We would be happy to discuss how mezzanine financing could work for you.

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