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Subordinated Debt

Companies that are experiencing higher growth rates with solid, steady historical cash flow (EBITDA - Earnings Before Interest, Taxes, Depreciation and Amortization) can further leverage their balance sheets after assets have been fully utilized. Mezzanine debt sits in the capital structure between the company's senior secured debt and equity. Otherwise known as subordinated debt, this capital typically involves a higher cost, with current interest rates between 10%-15%. Many mezz funds call their debt "patient capital" because it is often marked by a period of interest only payments with limited early amortization of principal that ramps up over the life of the deal. The typical mezzanine transaction has an loan term of 3-5 years. These deals usually also feature some form of non-cash "yield enhancement" to increase total return to the fund to between 18% and 22%.

The chart on the right shows typical deal metrics that industry players use as a rule of thumb to determine a company's capacity for debt. While the senior lenders max out with a total debt / EBITDA ratio of approximately 3.0x, mezzanine providers would be typically willing to allow for another 2.0 turns of debt principal to be layered into a borrower's balance sheet, reaching a total debt / EBITDA ratio of as much as 5.0x.

For example, if a company has a trailing twelve months' EBITDA of $2.0 million, such a business would theoretically be eligible for $6.0 million in total senior debt (depending on collateral values and traditional advance rates, of course) and another $4.0 million in subordinated debt. There are many factors that determine debt capacity in different industries, however. For instance, a higher growth company with better margins would most likely merit a larger overall debt level than a stagnant business that sells a commodity product.

Essex maintains close relationships with numerous mezzanine funds across the U.S. that fill every conceivable niche in terms of borrower credit quality, industry, facility size and geography. We welcome contact from companies considering raising a round of growth capital to determine if subordinated debt would be an appropriate solution. If available, this type of capital is frequently more advantageous than taking on an equity investor.

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