| MEZZANINE CAPITAL: FOCUS ANNOUNCES ITS FIRST FUND, FOCUS MEZZANINE. IS IT RIGHT FOR YOU? FOCUS is pleased to announce the creation of its first fund, FOCUS Mezzanine, a middle market mezzanine fund providing subordinated debt financing for middle market operating businesses.
The new Fund -- managed by Prudent Management LLC, a seasoned mezzanine fund management firm based in Washington, DC -- will make subordinated debt and preferred equity investments in successful, later-stage middle market operating businesses. By providing mezzanine debt between $2 million and $10 million, FOCUS Mezzanine will fill a gap in the mezzanine debt market.
In a related article -- “Is Mezzanine Capital Right for You?” -- Steven J. Schwartz, attorney, CPA, and seasoned mezzanine fund manager, presents a variety of diverse situations for which mezzanine capital may be appropriate for middle market business owners in the market for capital.
Mr. Schwartz is Fund Manager of Prudent Capital
LP and FOCUS Mezzanine. For 23 years, Mr. Schwartz was Chief
Financial Officer and General Counsel to a diversified group
of companies that included general contracting, real estate
leasing, property management and development, radio broadcasting,
telecommunications, software development, wholesale distributorship,
and a golf course. He also practiced law for three years
with Tucker Flyer (now merged into Venable) and practiced
public accounting for five years with Aronson and Company.
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New FOCUS Funds Initiative Debuts with FOCUS Mezzanine Fund
By Mark Capaldini, Partner & Chief Marketing Officer, FOCUS Enterprises, Inc.
FOCUS is pleased to announce the creation of its first fund, FOCUS Mezzanine, a middle market mezzanine fund providing subordinated debt financing for middle market operating business.
FOCUS Mezzanine will make subordinated debt and preferred equity investments in successful, later-stage middle market operating businesses. By providing mezzanine debt between $2 million and $10 million, FOCUS Mezzanine will fill a gap in the mezzanine debt market.
Many middle market companies require debt capital outside the typical parameters of commercial banks. FOCUS Mezzanine is designed to satisfy this capital shortfall and to help middle market companies achieve their goals. Typical uses of capital include acquisitions, recapitalizations, and financing rapid growth.
FOCUS Mezzanine seeks middle market companies with a proven product or service, annual revenues in excess of $5 million, significant profits, and an experienced management team. While banks typically loan money based on the value of the collateral a company is able to provide, FOCUS Mezzanine invests in middle market companies based on the amount of free cash flow the company consistently is able to generate.
FOCUS Mezzanine welcomes “old economy” businesses with modest growth expectations as long as there is a proven track record of successful operations. In addition, FOCUS Mezzanine's value-added services will satisfy the many middle market companies that seek capital not based solely upon the financial terms of the investment, but also based on the investor’s ability to help build the company.
FOCUS Mezzanine Provides Debt and Equity
FOCUS Mezzanine invests between $2 and $10 million in middle market companies in the form of either debt or preferred equity. These investments are subordinate to the middle market company’s senior debt financings and have priority over the company’s common equity capital.
Debt Investments
FOCUS Mezzanine’s debt investments typically have origination fees, a current interest rate of between 12 percent and 15 percent, plus detachable warrants for common equity of the business.
Preferred Equity Investments
FOCUS Mezzanine’s preferred equity investments typically have origination fees, no current payments, a preferred liquidation value which must be redeemed after three to five years plus detachable warrants for common equity of the business.
Investment Criteria for Middle Market Mezzanine Debt
FOCUS Mezzanine provides expansion capital to later-stage, privately held operating businesses. Such businesses must have a commercially proven product or service plus substantial revenue and profits. No start-ups or early stage companies will be considered.
Depending on the type of company, FOCUS Mezzanine evaluates many criteria as part of its disciplined and opportunistic approach to investing. The emphasis placed on each criterion is dictated by the particular situation. Some of these criteria include:
- A strong, experienced, committed management team that is financially motivated and whose incentives are aligned with FOCUS Mezzanine’s investment.
- A well thought-out, credible operating plan, financial forecast, and capital structure that supports anticipated growth. Minimal cyclicality, strong downturn resiliency, and low risk of technological obsolescence.
Demonstrated track record, strong market position, potential for future growth, and strong customer and vendor relationships.
- Demonstrated ability to achieve a low-cost operations and large margins sufficient to generate reasonably predictable free cash flow.
- Favorable gross margins and net income as compared to competitors. Significant barriers for competitors to enter the business.
In addition, all investments will involve businesses that FOCUS Mezzanine believes it has the expertise to evaluate and that have sufficient credit quality and debt service coverage. The businesses also must meet FOCUS Mezzanine's return criteria and be structured to provide as much down-side protection as possible as well as demonstrating multiple potential exit strategies to gain liquidity and realize equity appreciation.
Detailed Information about FOCUS Mezzanine is Available at www.focusbankers.com
- Value-Added Services for Middle Market Mezzanine Debt
- Financial Terms for Middle Market Mezzanine Debt
- Middle Market Preferred Equity Investment Criteria
- Financial Terms
- Investment Process
- Information Required for Preliminary Investment Evaluation
- Fund Management
*Mark Capaldini, FOCUS Partner and Chief Marketing Officer, can be reached at Mark.Capaldini@focusbankers.com.
Is Mezzanine Capital Right for You?
By Steven J. Schwartz, Fund Manager, Prudent Capital LP and FOCUS Mezzanine
How do you know if mezzanine capital is an option you should consider for your business? There are a variety of diverse situations for which mezzanine capital may be appropriate. Consider three examples, all of which are good candidates for mezzanine financing.
- You have a profitable, growing business that could grow much faster if only you had the capital necessary to increase the amount of inventory you maintain; but, your bank is only willing to advance you 50 percent of the cost of such inventory.
- You are the President of an established, profitable company and the owner is thinking of selling the business and you would love to buy it, but the sum of the cash you are able to invest plus the amount that your bank is willing to lend you is not enough.
- You and your 50 percent partner have run a profitable business for many years and now he wants to retire to Florida and you want to continue working for at least another five years, but you are not sure where you are going to get the money to buy his interest.
Mezzanine Capital Defined
Mezzanine capital is the middle (or “mezzanine”) layer of capital between the senior debt provided by banks and equity provided by stockholders. Accordingly, mezzanine capital is generally subordinate to bank financing, meaning that the bank loan has a first claim on any of the assets of the business and generally has a right to be repaid before the mezzanine capitals.
On the other hand, mezzanine capital is senior to the company’s equity. Most mezzanine capital comes in the form of a loan that is secured by all of the assets of the business (in second position behind the banks). However, in some instances, mezzanine capital also can be in the form of preferred equity without any collateral or requirement to receive current dividend payments. Such equity usually has a requirement that it be redeemed prior to any payments to the company’s common equity.
Mezzanine Capital Providers Generally Focus on Cash Flow
While banks generally require that their loans be adequately secured with assets of the company, mezzanine capital providers generally focus on the cash flow generated from the operations of the business. Accordingly, the most important aspect of a company wishing to obtain mezzanine capital is that they have a proven track record of generating cash flow from their business.
This generally disqualifies start-ups and turnarounds from being good candidates for mezzanine capital. In addition, how the company plans on using the capital is important. Here are three good examples of when mezzanine capital is most helpful to:
- Fund inventory build-up,
- Facilitate a management-led, leveraged buy-out,
- Recapitalize the company.
As a general rule, a company seeking to establish a sales and marketing organization, to cover operating deficits, or to provide partial liquidity to an owner who remains active in the business, should not use mezzanine capital. Those uses of capital are more appropriately funded with equity.
Companies Should Maximize Capital Sources in Order of Cost
Since return expectations are correlated with risk, bank loans are the cheapest source of capital for a company, then mezzanine debt, then mezzanine equity, and then common equity. For this reason, it is best for a company to maximize each type of capital in the order of their cost.
Only after a company has obtained as much bank debt as the bank will provide (including a revolving line-of-credit and term loan), should a company consider mezzanine debt. Then, only after a company has obtained as much mezzanine debt as the mezzanine capital provider will provide, should it consider mezzanine equity, and so forth. Utilizing this financing strategy will minimize the company’s cost of capital and allow the company’s owners to retain ownership of as much of the company as possible.
Economies of Scale Also Apply to Capital
The actual cost of each type of capital will depend on many factors as well as upon the amount of capital required. Economies of scale apply to capital, as they do to almost all supplies. So, the more capital the company needs, the cheaper the cost of the capital. Those businesses requiring in excess of $10 million most likely will pay less for their capital than a company seeking less than $10 million. This is because there are so many capital providers competing for the over $10 million deal size.
One reason that there are so many providers to the over $10 million segment of the market is because they all have a lot of money to invest; and, since the amount of effort to find, underwrite, and close a large deal is not much different than it is for a smaller deal, they prefer to spend their time on the larger deals. There still are many choices of mezzanine capital providers for loans under $10 million, but the cost is slightly higher.
Cost of Mezzanine DEBT of $10 Million or Less
For mezzanine debt of $10 million or less, expect to pay origination fees of 1 to 3 percent, a current interest rate of between 12 and 16 percent, and options to purchase equity in the company (referred to as detachable penny warrants) so that the capital provider’s total annual rate of return on their investment will be between 20 and 25 percent.
Cost of Mezzanine EQUITY of $10 Million or Less
There are many fewer providers of mezzanine equity of $10 million or less; but, if you can locate one, expect to pay between 30 and 35 percent annually for their equity investment. These yields are still less than institutional common equity investors who require more than 35 percent a year.
Advantages of Mezzanine DEBT
In addition to cost, there are many other advantages to mezzanine debt as compared to equity. Most institutional common equity investors require a controlling interest in the company. Most mezzanine providers only require the right to regularly receive financial information about the company and the right to attend the company’s board meetings as an observer.
In addition, most institutional equity investors require a high growth rate for the business to achieve their desired rate of return. Mezzanine providers will accept a business with limited or no growth potential so long as the business has consistent earnings sufficient to service their debt. Some mezzanine providers will even limit their rate of return on their investment, while equity investors almost never will.
Business owners should carefully weigh all of the factors discussed the next time they are in the market for capital. And, if they qualify, they should consider mezzanine capital debt -- after they have met with their banker and before they consider equity.
Steven J. Schwartz is Fund Manager of Prudent Capital LP and FOCUS Mezzanine, based in Washington, DC. Both funds specialize in investments between $1 and $10 million to successful, middle market companies.
Atlanta Business Chronicle Features FOCUS Atlanta Office
The cover page of the Strategies section of the November 25th Atlanta Business Journal opens with a nearly full-page, full-color photo -- captioned “Focused on the future” -- that includes most of the FOCUS Atlanta Partners plus Dick Cook, a Senior Advisor to the firm and who is based in Atlanta. The major article by Tom Barry highlights the success of FOCUS in the Atlanta market, and includes a sidebar, “Maximizing M&As,” with two informative checklists: “Before Buying a Company” and “Before Selling a Company.” Here is a short excerpt:
'Tis the Season to Buy and Sell Companies
“Sensing opportunity, Dick Cook joined FOCUS Enterprises Inc. in early October, signing on as a senior adviser with the Washington, D.C. based investment bank that established an Atlanta office last spring.
The Atlanta beachhead serves small to midsized companies across the Southeast -- businesses with between $5 million and $100 million in annual revenue -- in a mergers-and-acquisitions market that's been running at a red-hot pitch”…more
RECOMMENDED READING: Bigger Isn't Always Better for M&A as Smaller boutique Firms Score Well for Clients
In the November 19, 2005 The Wall Street Journal, Gene Colter’s column, “Deal With It,” cites a new study by Thomson Financial that crunched the numbers of hundreds of deals, with the following results:
“…smaller investment boutiques drove some of the best deals for clients. Raymond James Financial Inc., for example, snagged average premiums of 77 percent above the market value of a handful of client companies that were being acquired, versus 41 percent premiums for companies advised by bankers at Citigroup Inc., the next best performer.
On the acquiring side, Wachovia Corp. helped negotiate deals in which clients paid an average of only 6.8 percent above the target's value. Citigroup again ranked second at 17.8 percent, followed by Deutsche Bank AG and Credit Suisse Group's Credit Suisse First Boston, both at about 19 percent.”
About FOCUS Enterprises,
Inc.
Headquartered in Washington DC, with offices in Atlanta, Chicago, and San Francisco, FOCUS provides a range of investment banking services tailored to the needs of middle market companies. FOCUS specializes in transactions for entities with $5 to $100 million in revenues, serving entrepreneurs, corporate owners, public companies, private companies or operating units, and various types of investors.
For 23 years, FOCUS has successfully integrated corporate development consulting and transactional expertise with its extensive research capability. The firm has long standing experience in completing mergers, acquisitions, divestitures, capital formation assignments, corporate development consulting projects, and financial advisory engagements.
Over twenty FOCUS Partners and Principals provide over two centuries of C-level operating experience in a variety of industries.
Please contact us at: info@focusbankers.com.
Visit the Focus website at http://www.focusbankers.com.
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