Businesses need funding to grow, and small and medium enterprises often find it difficult to obtain debt financing because banks and NBFCs are wary to lend to small businesses. The limited collateral, erratic cash flow, and below-average debt-to-income ratio become pain points when it comes to raising debt. The growing demand for alternative financing has therefore led to the growth of alternative asset management i.e., Venture Debt, and Private Credit/Debt firms.
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| Ankur Agarwal, Co-Founder & CTO, PE Front Office |
These Alternative Investment firms can provide funds to small and mid-sized enterprises quickly and efficiently in different forms i.e., equity, debt, and mezzanine debt, etc. When it comes to equity and debt financing, enterprises may be apprehensive because either they may not want to dilute the ownership stake, or they may be unwilling to borrow debt due to a lack of collateral or reluctance to provide a personal guarantee.
Mezzanine/Hybrid financing fills the gap between equity and debt in terms of payout priority — superior to equity and subordinate to senior debt. While there can be multiple ways in which a Mezzanine debt can be structured, the most commonly used structure is the one that has an equity component in the form of warrants. Mezzanine debt also known as subordinated debt, offers flexible repayment terms such as monthly or quarterly Interest payments, with the principal to be repaid at final maturity. Further, there can be a convertible structure that allows the lender to convert all or a portion of the principal into equity. Mezzanine funding is also ideal for companies that don’t have the capital to self-finance big expansion moves or those with good positive cash flows.
Mezzanine/Hybrid Debt is an ideal option for borrowers as it offers the following benefits:
The ever-rising numbers of deals and investments have made the task of Investment managers very tough, given that most Alternative Investment firms still rely on traditional tools like Excel to manage their investments. Therefore, it is worthwhile to also discuss the benefits that technology offers in managing Mezzanine/Hybrid debt investments by addressing some of the major pain areas such as:
If used strategically, both enterprises and Alternative Investment firms can benefit from Mezzanine funding. For enterprises, it is a good funding option that offers to reduce the cost of capital while ensuring that there is still an opportunity for borrowing funds from banks. On the other hand, for Alternative Investment firms, Mezzanine investments offer some of the highest return rates.
(The Author of the article is Ankur Agarwal, Co-Founder & CTO, PE Front Office)
Mezzanine/Hybrid financing fills the gap between equity and debt in terms of payout priority — superior to equity and subordinate to senior debt. While there can be multiple ways in which a Mezzanine debt can be structured, the most commonly used structure is the one that has an equity component in the form of warrants. Mezzanine debt also known as subordinated debt, offers flexible repayment terms such as monthly or quarterly Interest payments, with the principal to be repaid at final maturity. Further, there can be a convertible structure that allows the lender to convert all or a portion of the principal into equity. Mezzanine funding is also ideal for companies that don’t have the capital to self-finance big expansion moves or those with good positive cash flows.
Mezzanine/Hybrid Debt is an ideal option for borrowers as it offers the following benefits:
- Designed to allow the owners to retain complete control of the company.
- Lenders do not interfere with the working of the business and remain passive.
- Does not require a personal guarantee or collateral.
- Offers less restrictive covenants than senior debt.
- Yields attractive returns between 12 to 20% annually which is considerably higher than other forms of debt.
- Ranked ahead of equity investors when it comes to repayment which offers a safer avenue to investors in cyclical markets.
- Offers the lender an option to convert the debt into equity at a future date.
The ever-rising numbers of deals and investments have made the task of Investment managers very tough, given that most Alternative Investment firms still rely on traditional tools like Excel to manage their investments. Therefore, it is worthwhile to also discuss the benefits that technology offers in managing Mezzanine/Hybrid debt investments by addressing some of the major pain areas such as:
- Tracking investment pipeline
- Capturing cashflow transactions including interest repayments
- Managing different Mezzanine debt scenarios, for example, conversion of investment from debt to equity
- Tracking periodic valuations and performance metrics such as IRR/MoC (Multiple of Capital or Times money back)
- Monitoring Portfolio Financials/KPIs and ESG metrics
- Investor On-boarding, Communication, and Reporting
- Managing Capital Calls and Drawdown/Distribution
- Tracking Fund Cost and Fund Performance Metrics
If used strategically, both enterprises and Alternative Investment firms can benefit from Mezzanine funding. For enterprises, it is a good funding option that offers to reduce the cost of capital while ensuring that there is still an opportunity for borrowing funds from banks. On the other hand, for Alternative Investment firms, Mezzanine investments offer some of the highest return rates.
(The Author of the article is Ankur Agarwal, Co-Founder & CTO, PE Front Office)
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