Avoid the Mezzanine Hype - Focus on Revenues

Tue, 10 Mar 2009 08:19:49 EST

We all know banks and large financial institutions are hoarding their money; they're not spreading the wealth garnered from any kind of stimulus plan. So, even if your company by now has some history and is demonstrating rapidly growing revenue and profit, likely you still will not get any kind of loan from a bank.

What's the hype? Mezzanine financing. But what is it and do you really want it?

Mezzanine financing is a hybrid of equity and debt financing. It is a vehicle that can bridge what a bank will lend and the capital you need to achieve your goals. It is used for short term cash flow to finance acquisitions, research and development, or working capital.

However, mezzanine financing is not appropriate at any economic time if you foresee your company will continually need funds in excess of what you're able to generate internally for an extended period of time. If you're trying to grow your company much faster than you can afford, equity is your answer, not debt. Under such circumstances, debt, whether traditional or mezzanine, will be your grim-reaper.

Now, assume that you've found a potentially great collaborative partner and a perfect acquisition target. Also assume you have a history of revenues and growth.

You need financing because there is insufficient working capital to run both your company and the target company at the same time, at least in the short-term. You also know by now that banks aren't going to help you. Do you look for mezzanine financing or an equity partner?

Last year, I would have advised debt financing as a preferable instrument over equity. In fact, in early to mid- 2008, there was a surge in mezzanine financing. At the time, though, such financing was fairly attractive. Although it is more expensive than traditional debt, mezzanine financing was appealing then because it was a much less expensive source of capital than equity financing.

It used to be that the cost of mezzanine debt was around 15 to 18 percent. The yields were high but generally manageable at around 12 to 14 percent, and the equity kickers were under 5 percent. With the all-in cost of equity financing being upwards of 35 percent, mezzanine financing was rather attractive. Not anymore.

Going into 2009, the mezzanine market is stagnant. Quite frankly, there's so little mezzanine financing because it isn't that appealing to private equity firms or enterprises. Private equity firms are just not interested in doing a deal without senior lenders being involved. Senior lenders are sitting out of the game for a while.

Furthermore, the price of mezzanine financing is just too high now. Starting in late 2008 and certainly going into 2009, the cost of mezzanine financing rivals that of equity. Now, the all-in cost is often about the same, around the 35 percent mark. Yields for some mezzanine financing deals are at 20 to 30 percent with equity kickers at 10 percent.

Ouch.

Until senior lenders jump back into the game and decide to do more than just offer a CD, for now, focus on equity deals.

Don't Waste Time On False Hopes - Focus on Driving Revenues
Your time is your company's most precious asset. While it is important to network, be wise about it. When you are out shaking hands and handing out cards, keep a look-out for more than just a potential capital source. Keep your creative mind open and network for potential avenues of business and mutually beneficial collaboration.

Chasing after the overenthusiastic investment bankers and commercial lenders trying to save their jobs whom you meet during networking events is likely a waste of your time. Several commercial lenders and investment bankers have admitted to me that they are actively meeting with prospects and taking applications and business plans, but not funding any them. They are filling their pipelines for the future.

If you don't focus on your revenues now, being in that pipeline won't help you. Furthermore, to land that illusive accidental angel, you must show revenues and growth. Sell, Sell, Sell.

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Avoid the Mezzanine Hype - Focus on Revenues