This Way to the Mezzanine

"

Mezzanine financing deals — bridge loans that span funding gaps until cheaper capital can be had — are on a roll. Last year, 159 buyout/mezzanine funds raised $86.2 billion, the highest yearly total for these funds ever recorded, reports Thomson Venture Economics, which groups the two funding sources together. That tally represents a 67 percent rise over 2004, when 129 funds raised $51.6 billion.

The upsurge in mezzanine lending follows the general private-equity trend of abounding capital chasing a relatively low number of deals. It may also signal that more small companies are reaching a growth stage in which such financing makes economic sense.

In general, mezzanine loans are short-term debt — usually averaging about three years in length — provided by private-equity firms rather than banks. The loans tend to be subordinated debt, exposing investors to more risk than bank lenders have in case of bankruptcy. So to entice investors into mezzanine funds, returns are set relatively high, between 30 percent and 50 percent. Further, the deals often feature warrants, which are options issued by the borrowers that give the lender the right to buy equity at a predetermined price.

Warrants are used to "juice the return" by enhancing an investor's potential yield with equity, explains Ricardo Chance, a managing director with investment bank Trenwith Securities. But to an entrepreneur shepherding a growing company, warrants are a double-edged sword. While warrants help lure capital, they can cede a good deal of equity — and thus control — to the lender."

For more information, visit www.EvanCarmichael.com.