Mezzanine Financing Structures: Preferred Stock

April 4, 2011 / admin posted in Mezzanine / Comments Off

One of the most common methods of funding a mezzanine loan is through the issuance of Preferred Stock.  Remembering our visual of where mezzanine seating is in a theater or stadium, it falls in the middle of bank borrowing (where it sits below in priority) and common stock holders (where it sits above in priority).

What Is It

So whats the difference between Preferred Stock and Common Stock??

There is a Preferred status attached to preferred stock, which means they get paid off prior to the common stockholders, who get paid off last.  This allows it to qualify for our middle seating of being in the mezzanine.  There are two main differences:

1) Dividends

Preferred stock often has a regular and reliable dividend where common stock may or may not have a dividend.  Dividends are typically guaranteed to preferred stockholders, where there is no assurance a dividend will ever be paid to a common stockholder. This aspect and the higher priority of payoff from the company make Preferred stock closer to a hybrid security of part stock and part bond.  Thanks to the regularity of payments, its also called a Fixed Income Security.

2) Voting Rights

Preferred shares often have no voting rights as their claim on the company is more senior to the common stockholders and payment to them is expected, like a bondholder, but in the form of a dividend. Common stockholders do have voting rights and can elect the Board of Directors to implement their plans for the company.

Preferred Stock’s Use in Mezzanine Financing

There are 3 common methods of using preferred stock in funding mezzanine transactions and they are

All preferred stock

Some debt and some preferred stock

Use of convertible preferred stock

 

Since preferred stock falls in line with our ‘middle’ definition of mezzanine, then this means that a mezzanine lender can choose to fund a deal entirely with preferred stock. This can and does happen.  What is more common is to have a debt component where there is some borrowing.

Why?

Borrowing supersedes Preferred stock on the payoff list and the order of claims to the company’s assets so it would be perceived as lower risk for a lender to have at least some in the form only borrowing.

Convertible preferred stock is stock with the preferred status and dividends attached that has the option to convert to common stock.  This type of stock is attractive if the lender believes the company will grow and would like the chance to lock the price in now of where they can buy their shares and either hold or instantly sell at a profit.

There are many different ways to fund a mezzanine transaction and the 3 just in preferred stock alone show just how flexible this type of funding can be to find a way to structure a deal that is appealing to all the parties involved.

Stu Lustman

Southern Lending Solutions

Mezzanine Financing Structures: Debt with Warrants

April 1, 2011 / admin posted in Mezzanine / Comments Off

What It Is

A warrant is similar to an option on a stock.  Both are contracts that have an expiration date and allow the holder to purchase the underlying stock at a specified price between the time when issued and the expiration date.  The only major difference is the option has more flexible language that says the holder has the right but not the obligation, where the warrant holder simply has the right given to them if they choose to accept it.  Also, options are often paid for by an investor and warrants are given to a lender or preferred/institutional investor.

 

What Does This Have To Do With Mezzanine Financing?

One of the most common structures is for a Mezzanine lender to issue debt for the specified term, say 3 to 10 years at market rates or slightly below (Market for mezzanine is about 3-4% per year above bank lending rates).  This debt often has warrants attached as an equity kicker, allowing the lender to generate additional return and compensate them for their risk since they subordinate to the bank and some other forms of lending.

Who Can Issue Warrants?

Warrants can be issued on Private or Public Companies but Private companies are more complex as language has to be included about how to value the company and value the warrants to see if they are profitable for the warrant holder. Public companies only have to use an average of a agreed upon number of trading days to come with a value, for instance, upon desire to exercise a warrant then they take the average of the 5 previous trading days in the market to determine the price.

What Does It Matter?

Since a warrant is a right to purchase stock, then the mezzanine lender can become an equity holder in the company. In other words, a part owner.  So the Borrower better understand how much of their company could go to the lender and understand that this lender may become an actual partner/owner in the company.  Warrants make the debt part of the mezzanine financing easier and more palatable to approve from the perspective of the lender and their underwriters but only when its perceived as a good deal for all parties will a deal get completed.

Stu Lustman

Southern Lending Solutions

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

The Role Of The Chinese Intermediary

February 20, 2011 / admin posted in finance, lending / Comments Off

Any one who has conducted business in the Asian marketplace has inevitably run up again the role of the Chinese intermediary. Since the Chinese never conduct business face to face with people they don’t know, it is customary for them to use a go between.  This may be an individual or company responsible for making introductions or to spearhead the entire project. Since it takes a considerable amount of time and is often mired in bureaucracy, one should be prepared to pull up a chair.

I have communicated with many individuals regarding this very topic so I have become somewhat of an expert. Many Chinese businesses have relocated to more open and transparent markets such as  Hong Kong, Singapore, and the US, in an attempt to take take advantage of liberal business standards. That being said, the role of the intermediary is still as important as ever. As in any business transaction the more outside entities involved, the more likely hood of important facts to be lost in translation. Crucial details to a deal can be distorted by the time it’s  communicated through the various parties.  This is simply one more obstacle in a chain of obstacles that can discourage international business. As the older members of these Chinese companies hand the reigns down to the newer generation of leaders, the Chinese intermediary will become less of a dominant figure. Until than, anyone wishing to conduct business in the Asian market place should be prepared to face off with this custom.

Todd Rome
Southern Lending Solutions

Which Markets are Open for PiPEs?

February 18, 2011 / admin posted in PiPE/Structured Equity / No Comments

We get asked this pretty often since there are many markets that do not have very liquid or actively traded stock exchanges resulting in a need for increased capital for many smaller public listings.

The most favorable market and most favorable terms come from US companies and/or Foreign companies that listed on the Over the Counter (OTC), Bulletin Board, or Pink Sheets. However, we have other markets we like very much and they include:

Canada

Australia

UK and EuroZone

The Far East: Singapore, Hong Kong, Malaysia, Indonesia, Taiwan

South America: Brazil, Uruguay, Argentina, Chile

If your market is not on this list, then just email us at info at southernlendingsolutions.com and ask us and we will get back in touch with you right away. There are very few markets that are entirely restricted so most not on this list are qualified on a deal by deal basis.  And NO, we cannot do any China based listings at the moment.

Our most recent PiPE candidate deal is one of these foreign companies that happens to be listed on the OTC so don’t be shy if your company or client is listed somewhere overseas.

Stu Lustman

Southern Lending Solutions

PiPE/Structured Equity Client Case Study

February 14, 2011 / admin posted in PiPE/Structured Equity / No Comments

The client in question is a good example of why a company would want to use this Structured Equity/PiPE solution.  They asked to be kept confidential so we are respecting their privacy.

The client is in a commodities business and has a chance to both acquire a competitor and acquire some additional strategic assets.  The cost of both is $14 million USD.

The problem?  They do not qualify for a stock loan as their stock only trades the equivalent of about $30,000 USD per day so nowhere near enough volume to qualify for a loan.  The other problem?  The market value for the entire company based on current level pricing is $20 million USD.

What other reasonable option do they have to raise this money?

The most obvious option is to go back to the investment bank that took them public. This means going to the Merrill Lynch, JPMorgan or Goldman Sachs of the world.  No question they could do this but 2 things would happen as a result:

  1. The financial markets would find out the competitor and the strategic assets were ‘in play’ and drive their price up.
  2. They would likely have to pay $2 million USD or more in fees to get these additional shares issued.

How does our solution work around these problems?

  1. The assets are not divulged to be ‘in play’ as it’s a private fund investing in the Client company and the Client only has to disclose to the investment fund the purpose for the funds and no one else
  2. Our fees are significantly less, about 75% less than the investment banking solution

So this is a good fit for our Client company so they can lock in the price without any bad feelings by the selling company or the holder of the assets being purchased and by paying lower fees than to their investment bank, more of their money goes to work for the acquisition and growth of the company creating a true win/win/win scenario for all.

Stu Lustman

Southern Lending Solutions

Glossary of Terms in the PIPE Term Sheet

February 9, 2011 / admin posted in PiPE/Structured Equity / No Comments

The term sheet for our PiPE program has some potentially complicated and confusing terms in it so I figured a glossary and explanation would be in order to make understanding the term sheet a little bit easier.

Advance Date: this is the date when a tranche of funding occurs.

Pricing Period: this is the number of consecutive trading days after the Advance Date that is used to calculate the purchase price of where the investment fund is buying the shares. This is the how much and where are they priced question.

Purchase Price: this is the how much based on the pricing period based price the investment fund is paying. This number is needed as its usually at a slight discount to market. Our latest deal has a purchase price of 90%

Advance Restrictions:  this is the number of days required in between advances to the client.  Can be as short as every 5 days or be as long as every 4-6 weeks.

Commitment Shares: this is the added (meaning extra) number of shares the investment fund gets as payment for funding the client.  For example, if the Commitment Share amount is 5%, then in essence the client is getting funded 100% of their amount but paying 105% to the investment fund.

No Shorting,  this is not a term that needs to be defined but all deals in this program have a promise of no shorting the stock

Floor Price: this is a formula used to calculate a minimum price paid by the fund for the shares. This is an insurance policy against one or two major down days affecting the price of the whole tranche amount.  If the average drops below this floor amount, then the client does not have to issue shares to our investment fund.

Due Diligence Fee: this is a fee paid to compensate our investment fund for the legal fees involved with completing the deal.  this fee is paid in ADVANCE of closing but after terms are agreed to and signed.  However if the investment fund ever decided to not fund the deal, then the client gets this fee back.

This is the bulk of what is found on the PiPE program term sheet.

Stu Lustman

Southern Lending Solutions

The Significance of the Capital Gains Tax in Securities Lending

February 8, 2011 / admin posted in finance, lending / Comments Off

The capital gains tax refers to a tax on on any gains received on the sale of stock or other asset.  Many countries have a capital gains tax but there has been a recent move to abolish this practice in the last decade. The US and many European countries recognize the capital gains tax.

How does this tax affect securities lending?
In countries where the capital gains tax exceeds 10%, it can make the terms offered by a lender much less attractive.  Of course the needs and desires to complete a stock loan will mitigate the effect this has on a particular deal. In other words, should a business or individual have a true need for financing, then securities lending is still one of the fastest ways to receive that funding.

Which countries have a significant capital gains tax?
* The US and India have some of the more steeper tax gains on record. Some Asian countries such as Singapore have none what so ever. Others have a variation such as a stamp tax which is assessed at the sale of a stock. One thing to take note of when considering the capital gains tax is when and how it’s triggered. Some countries will charge capital gains regardless if there is a sale or not. Specifically, the pledging or delivering of shares in some countries will by default trigger this taxable event, even though no sale has taken place.  For this very reason securities lending makes much more sense in some countries than it does in others

*Please note-I am not a tax adviser and as such the above is subject to interpretation. Always seek advice from a tax specialist should you have specific questions regarding the capital gains tax*

Todd Rome
Southern Lending Solutions

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