On June 6, 2017, Davis Wright Tremaine LLP hosted the latest edition of our Family Business Study Group, where David Levine of Prudential Capital Group and Hugh Campbell of Cascadia Capital spoke about using mezzanine financing to create liquidity in family-owned business.

What is Mezzanine Financing?

Mezzanine financing is used to facilitate a variety of transactions, including buyouts, acquisitions, recapitalization, refinancing, and growth financing. It is a hybrid of debt and equity designed to bridge the gap between the amount a senior lender will provide and the amount of equity capital that owners or buyers are willing to commit. Mezzanine gets its name because it blurs the lines between what constitutes debt and equity. The debt component is typically a loan with cash interest and payment in kind (PIK) interest which accrues and is paid on maturity. The equity component tends to be in the form of warrants to purchase equity or conversion rights to common stock.

Who Benefits from Mezzanine Financing?

Companies in one or more of the following situations are likely to find mezzanine financing an attractive alternative to straight debt or straight equity financing:

  • The business needs capital but the owners do not want an equity investor.
  • Management does not want to relinquish control or dilute their equity.
  • The business cannot afford to assume the risk of a floating interest rate.
  • The business can only obtain senior debt by agreeing to pay the lender a high rate of interest, accept covenants that are too restrictive, provide personal guarantees, or put up more collateral than it chooses to put at risk.

Why is Mezzanine Financing Appealing?

  1. Less Dilutive and Fewer Control Provisions. Equity capital, by its nature, dilutes existing shareholders. Unlike series financings, mezzanine keeps the family in control of the business; it does not require any type of management control or voting position. While the owner loses some independence, he or she rarely loses complete control of the company or its direction.
  2. Cheaper Than Equity. Mezzanine is a cheaper alternative than additional equity capital, and it requires only interest payments for relatively long periods.
  3. Patient, Flexible Capital. Mezzanine financing offers more flexibility to structure coupon, amortization and covenants to accommodate the specific cash flow requirements of a business. The non-amortizing nature of mezzanine and the use of PIK interest allow cash to be invested in the business for a longer period of time.