Mezzanine Fund
A. How can growth companies afford hybrid debt facilities, which are riskier and more expensive than senior loans obtained by mature value companies?
The Paradox: “Growth companies” notoriously generate lower Cash Flows than “Mature companies”, but at the same time Growth companies have to finance their business through more expensive instruments (mezzanine finance) as the information available to the public, i.e. the investors, are much less than those released by big and mature companies. Therefore Growth Companies have difficulties to finance their growth through “cheap” financial sources as “senior loans” and the only way to boost their activity is to rely on more “expensive” and structured instruments. How come?
First of all Growth Companies are in the “second stage” of the Business Life-cycle which means that are entering into an “Expansion phase”, i.e. those companies are expected to generate high cash flows in the near future. That said it’s intuitive to understand how a so-called “grace period” could be a viable feature that hybrid instruments provides to SMEs. While for most of the start-ups 1 or 2 years of “grace period” is not enough to reach the ability of generate enough cash flows in order to pay back the loans it may be the contrary for Growth Companies.
Moreover there are some advantages of mezzanine finance that justify the “paradox” previously discussed:
* The total yield of all versions of mezzanine capital can ultimately be broken down into an interest and a kicker element: one lower (relatively safe) interest element which is compensated by a very much higher (relatively unsafe) kicker element. The company and lender work together to avoid burdening the borrower with the full interest cost of such a loan. Because mezzanine lenders will seek a high return, this return must be achieved through means other than simply cash interest payments. As a result, by using equity ownership and PIK (payable in kind) interest, the mezzanine
The Paradox: “Growth companies” notoriously generate lower Cash Flows than “Mature companies”, but at the same time Growth companies have to finance their business through more expensive instruments (mezzanine finance) as the information available to the public, i.e. the investors, are much less than those released by big and mature companies. Therefore Growth Companies have difficulties to finance their growth through “cheap” financial sources as “senior loans” and the only way to boost their activity is to rely on more “expensive” and structured instruments. How come?
First of all Growth Companies are in the “second stage” of the Business Life-cycle which means that are entering into an “Expansion phase”, i.e. those companies are expected to generate high cash flows in the near future. That said it’s intuitive to understand how a so-called “grace period” could be a viable feature that hybrid instruments provides to SMEs. While for most of the start-ups 1 or 2 years of “grace period” is not enough to reach the ability of generate enough cash flows in order to pay back the loans it may be the contrary for Growth Companies.
Moreover there are some advantages of mezzanine finance that justify the “paradox” previously discussed:
* The total yield of all versions of mezzanine capital can ultimately be broken down into an interest and a kicker element: one lower (relatively safe) interest element which is compensated by a very much higher (relatively unsafe) kicker element. The company and lender work together to avoid burdening the borrower with the full interest cost of such a loan. Because mezzanine lenders will seek a high return, this return must be achieved through means other than simply cash interest payments. As a result, by using equity ownership and PIK (payable in kind) interest, the mezzanine