Presentation on Mezzanine Financing 11 th November 2011 by CA. SANJAY KHEMANI 1
Flow of Presentation Mezzanine capital Definition Characteristics Uses Advantage and disadvantages Types of mezzanine finance Pricing Example Senior debt vs. Mezzanine vs. Equity Conclusion 2
Typical Financing structure Conventionally, any project s financing structure typically consists of Equity Debt However both has certain limitations 3
Equity - Limitations Equity Promoter's Limited resources External placement being costly Risk of dilution of control Risk bearing capacity of promoters 4
Debt- Limitations Debt Though low cost but requires collateral Regular servicing Ceiling imposition by regulatory authorities To overcome the limitations of both, we have MEZZANINE CAPITAL 5
Mezzanine financing- Meaning A hybrid of debt and equity Subordinate to typical debt Senior to equity It is a mix of traditional debt and equity financing that offers the benefit of both. 6
Mezzanine financing- Characteristics Flexible transaction structure Less dilutive to ownership than equity Little or no collateral compared to senior debt Mostly Privately placed Medium risk and medium return capital Medium to long term 7
Reasons to resort to Mezzanine financing Raising of capital without immediate dilution Cost effectiveness Leveraging the capital Inability to raise further debt Tax efficient structure Multiple structure with multiple objective Regulatory benefits 8
Mezzanine financing- Some Pre-requisites Attributes of companies seeking mezzanine finance experienced management team business strategy or vision that addresses rapid growth produces value-added products or services Foreseeable cash flow with some degree of certainty 9
Mezzanine financing- Advantages Optimisation of total cost of capital Boosts Return both on equity and absolute profits Less dilution of Control Flexible transaction structure Tax efficient 10
Mezzanine financing- Disadvantages Restrictive covenants. Lengthy procurement process Expensive compared to senior debts Complicated structure 11
Mezzanine financing- Pricing Complicated pricing involving present and future business valuation issues Priced appropriately between bank debt and equity financing Warrants to purchase stock, a royalty, or a revenue participation fee based on the growth of the business. 12
Types of Mezzanine loan Mezzanine debt can take many forms Common type of mezzanine financing are- Straight Debt Participating loan Preferred Equity 13
Straight Debt Instrument Key features: lender is in a subordinate position no equity participation in the cash flow no management participation Coupon step up/down depending on certain predefined events yields typically fall within the 15-18% range (depending on amount of leverage, type of project, and owner history). Typically subordinate debts of Banks and NBFCs are straight debt instruments. 14
Participating Notes Key features: lender is in a subordinate position, higher leverage with cash flow or equity participation by lender, Management participation slightly lower coupon rate on the note (ranging 8-10%) higher overall yield from the combination of the coupon and the equity obtained in the transaction. 15
Preferred Equity Key features: Provides lender some control over the project, along with a greater equity position. Parties usually enter into a partnership or joint-venture agreement, higher overall yield and the ability to step in in the event of default. 16
Funding structure-example Companies with efficient capital structures employ a number of capital sources Typical Private Equity Structure (% of Total Assets) Expected Returns (%) Senior Debt & Asset Backed Lending 30% - 60% 10% - 15% Mezzanine Finance 20% - 40% 15% - 25% Equity 20% - 30% 25%+ 17
Return on Capital- Maximization Financing instrument Financing structure PBT Equity 100 20 Return on Equity Pre tax-20.0% Post tax- 14% Debt @12% 50 Pre tax-28% 20 Equity 50 Post-tax-20% Debt @12% Mezzanine @18% Equity 60 20 20 20 Pre tax-43% Post-tax-32% 18
Debt vs. Mezzanine vs. Equity Senior Mezzanine Equity Typical Structure Revolving Debt Debt with warrants Equity Investment Horizon Short/ Long Medium/Long Long Security Secured Subordinate None Ranking Senior Second Third Risk Tolerance Low Medium High Term Demand Term/ Patient Patient Coupon Floating Structured Dividend Rate Prime Risk Adjusted Market Adjusted Equity Kicker None Warrants Shares Customization standard Rigid Flexible Flexible Liquidity High Low High 19
Mezzanine financing- Conclusion Flexible financing to achieve goals Mezzanine Debt can address limitations of both senior debt and Equity Potential to provide higher returns to the equity shareholders However, there is a lot of scope for conflict of interest between senior debt and mezzanine debt lenders Further, there is a risk of loss in control of the equity shareholders, incase the covenants not met 20
THANK YOU 21