An Introduction to Mezz Lending

With increasing appeal to investors and a growing presence on Axial, mezzanine lenders have recently become a particularly interesting topic. Has their rise been related to the economy? Or will investors begin to warm to this alternative style of lending? On Friday, we asked Don Rice, Darl Petty, and Brian Kerr of Penn Mezzanine to lead a Webinar and discuss some of the basics of mezzanine lending. Here are some of our major takeaways from the Webinar.

Note: You can find the full webinar at the bottom of the article.

What is Mezz Lending?
Mezzanine is a unique style of subordinated lending that mixes debt and equity. The debt component usually comes with interest rates of 12%-16% for a typical life of 4-6 years. Unlike most senior debt lender and banks, these interest rates do not typically fluctuate with prime and/or LIBOR rates. Don Rice explained, “[Mezzanine] is a hybrid of debt and equity, making it quite flexible. The flexibility enables it to be used in a variety of situations — including buyouts, corporate takeovers, mergers, acquisitions, growth capital, or recapitalizations.”

He continued, “Penn Mezz, and the majority of mezzanine firms in the market, employ a generalist, diversified strategy of investing across a variety of industries.” Penn Mezz tends to focus on the lower-middle-market, investing in companies in the United States and Canada with revenues ranging from $5MM – $50MM.

What is the Current Status of Mezz Lending in the US?
Mezz is currently on relatively solid footing – Darl Petty responded that, “It is a vibrant market today. Things have gone from serious concerns and little deal activity to quite a frothy environment. Demand and supply are both very high. We hear the same general opinion from most of our peers.”

“It’s funny, there is always some article, about every 8 – 10 years, arguing that mezz is dead. But, of course, that is never the case. Mezz is being used a lot — and not only in buyouts — but in many growth situations. With the banks being half aggressive and half scared, it’s a good time to get deals done.”

How do Mezz Shops Value Companies?
As it turns out, mezz lenders share much of the same due diligence criteria as equity lenders. Brian Kerr explained, “There are multiple factors that contribute to the attractiveness of an opportunity. In addition to the use of proceeds, amount of proceeds, type of transaction, and so on, we like to look at the management team and its past experience with leverage. In reality, it is very much akin to what an equity investor looks for in a business — a scalable business model, recurring revenue, and strong EBITDA margins to weather any dip or downturn.”

What are the Benefits of Mezz?
One of the biggest benefits of mezz is their partner-like mindset and significantly less dilution to the borrower as opposed to a direct equity investment. Darl Petty of Penn Mezz explained, “Mezzanine is more like a private equity firm than a bank. We are a lender by design, and our capital is deployed as debt, but we think more like a partner. We have a lot of value-added involvement with the company, always attending Board of Director meetings and bringing resources and ideas. We are really more like a partner than we are a lender.”

He added, “We work extensively to help our companies through our network and the resources that we can bring to bear. Because of the structure and the equity element of mezzanine lending, we are very motivated to see the equity value of the company increase.”