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Uses for Mezzanine: Management Buyout

March 22, 2011 / admin posted in Mezzanine / Comments Off

How It Happens

I can do it better.

Anyone who has been in business for themselves has said this at least once, after all if we didn’t then we would decide to go be an employee somewhere else instead of start our own businesses.

For some of us, we realize we can do it better where we already are.  Management’s role is to execute the plan and strategy as determined by the stockholders (since they own the company) as told to the Board of Directors.  Since management is in the trenches and dealing with the business and its markets everyday, sometimes they have insights that stockholders  or the Board may not possess.

So management has the ideas about how to grow the company but doesn’t have the funds? What do they do?

A Possible Solution

Mezzanine financing can be used to finance this type of acquisition, which is really known as a Management buyout. Buyout being the buyout of the shareholders so management now owns the company.  Mezzanine financing is one of the ideal forms of financing for a management buyout since things like the personal credit of the borrowers, and there will be multiple borrowers since a management buyout is usually led by some or all of the management team, are not a factor in the financing decision.

So we have numerous people in the management team ready to buy out and run the company themselves.  What is the source of the borrowing? What is the collateral?  Imagine being faced with multiple members of the management team having to put up their personal wealth or equity in their homes, if they have any,  to put up their portion of the company purchase price.

What a mess.

Solving The Problem

Enter Mezzanine Financing.  Mezzanine Financing at its core is cash flow based lending with the cash flow in question being the cash flow from the company.

So we can use the cash flow of the company we are buying to finance the acquisition of that company?

Yes, pretty sweet huh?

Benefits to Management Team Using Mezzanine Financing

Here are some benefits for the management team of using mezzanine financing:

Little or None of their own money in the transaction

Strong Cash flow is required for approval which means the acquisition candidate has to be strong to qualify

Smoother, cleaner, faster transaction than mixing and matching pieces from multiple members of mgmt team

Often give up no equity or at worst a preferred stock status to lender

100% of purchase price can be financed

One of the simplest and easiest ways for management to buy out the existing shareholders is to use mezzanine financing to fund the purchase.

Stu Lustman

Southern Lending Solutions

More From the Mezzanine

March 14, 2011 / admin posted in Mezzanine / No Comments

With the mention of EBITDA and Operating Cash Flow in the last post, I thought now would be a good time to go over the Cash Flow Statement, otherwise known as the Statement of Cash Flows or Funds Flow Statement.  Its purpose is to measure the amount of cash moving in and out of a business at any given time.

What is It?

The Cash Flow Statement is broken up into 3 areas and they are:

1) Operations

2) Investing

3) Financing

Operations

Cash Flow from Operations is much like it might sound. It is the cash flow from the business doing what it does. Does it sell widgets or build houses or import goods?  Whatever it does it’s the measure of cash flow that is generated from the business doing its business.

Investing

Cash Flow from Investing means cash flow generated from investments like the purchase or sale of an asset or a loan made to a supplier or customer or perhaps a payment made related to an acquisition.  So as you can see, while important, these are not cash flows from the core operations of the business.  However, assets can be sold to bring in more cash or a loan can be made that takes cash out of the business and this has to be accounted for too.

Financing

Cash Flow from Financing means the cash flow generated through financing activities like payments out to shareholders of dividends or the sale or repurchase of company stock or repayment of debt principal like in an equipment financing.

Are all 3 areas of equal importance?

While all 3 are important to a business, the one that concerns the Mezzanine lender the most is the CF from Operations.  A mezzanine loan is essentially a cash flow based loan to a growing company so the cash flow from operations tells us:

Is your company profitable at doing what you do?

If so, the CF from Operations will be positive though the overall cash flow for the company may not be positive due to other factors.

So which one most closely resembles EBITDA?

That would be cash flow from operations  since earnings before interest and taxes is a good measure of the business operation itself and a good proxy for if the mezzanine lender can expect to get their funds paid back to them.  Positive Operating Cash Flow or EBITDA is the first step towards securing mezzanine financing.

Stu Lustman

Southern Lending Solutions

Mezzanine Financing an Intro

March 7, 2011 / admin posted in Mezzanine / No Comments

When sitting in a stadium or at the theater, what do you think of when hear the word Mezzanine?

You probably think of a section of good seats that are in the middle somewhere. That’s exactly what Mezzanine Financing is. Mezzanine financing is in the middle. The middle of what?  It’s in the middle of debt and equity.  It sits below Bank debt and other debt obligations but sits above (in the pecking order)  Preferred or Common Equity. Mezzanine always gets paid off first prior to the stockholders.

Order of Payoff:

Bank borrowing, bonds

Mezzanine Financing

Stockholders

What form does it take?

Mezzanine can be in the form of all debt, known as subordinated debt since it’s a lower class of debt (subordinates) to bank debt. This is the most common.  Mezzanine can also take the form of a hybrid of some debt and some equity investment in the business or it can take the form of all preferred equity, which would make them just ahead of the common equity stockholders in terms of payoff.

What does it take to qualify?

Mezzanine works best for companies that are growing and running a positively cash flowing business.  This is usually measured by EBITDA, the acronym that stands for Earnings Before Interest, Taxes, Depreciation and Amortization.  This is often used as a proxy for Operating Cash Flow for the business of the Cash Flow from Operations section of the Cash Flow Statement from the Business Financials.

EBITDA+ $1million or more preferred,  $500,000 minimum

Special Cases where there is clear Enterprise Value and Equity in the Company like a Young Company with Patent Protected technology

Financing needs of at least 1 million USD

What’s it used for?

Growth or Project Related Financing

Acquisition Financing

Entering New Markets

Bridge Financing

Working Capital

Recapitalizations

Management Buyout

Turnaround Financing

Any reasonable use the company decides

Rates for Mezzanine are higher than bank borrowing but often much cheaper than the amount of equity that would have to be given away in a private placement.  Terms can vary from short to intermediate term (1-3, 3-10 yrs) and payment structures can be customized for things like seasonality or backloaded so more is payable during the time when the cash is the most productive.

Stu Lustman

Southern Lending Solutions