Urgent Help: Mezz Debt and Distressed Debt Investment
Hey guys, quick question here: Could someone explain what kind of target is good for mezz debt investment in a LBO? Imagine some of the element will be similar (eg: steady cash flow). So guess the real question is, what are the different criteria that you will look at vs. a equity investment in an LBO?
Also, what are the key things that you will look at for a distressed debt (special situation) investment? Obviously you need to get convinced by the turnaround story, but anything that is more specific?
Thanks. Am having an interview coming up and the company invests in both mezz and distressed other than traditional sponsor equity.
Feel free to PM me if you want share the comments privately. Thanks!!!
Cannot really speak to distressed, but for mezzanine investments, we tend to focus more on downside risk vs. potential upside. It doesn't need to be the moonshot homerun type of investment, we just need to make sure we'll get paid our 15-18% interest and get our principal back. So we look at coverage ratios, % debt repaid after 3/5/7 years, etc.
For an equity investment, you generally really have to believe there is significant growth potential or there is something about the business that will get you to your 25% IRR.
At my fund, we actually do a bit of both equity and mezzanine. If we don't really like the equity for the deal, we may throw our name in as a mezz lender.
Kenny's right.
As far as interest goes, 12-14% current pay and 4-5% PIK. And yes, it's an expensive loan, and companies generally do not want to pay it longer than they have to.
We've been refinanced out in 1.5-2 years, and we have some still outstanding for the past 4-5 years, so it definitely varies. Don't really think I've heard as short as 6 months, but I'm new...
I'll also add that you usually won't see mezz pieces in huge buyouts; the shops that do mezz typically gravitate towards MM and lower MM deals (this is by no means ALWAYS true, but typically), due to risk and size.
The mezz piece is in the deal in the first place because the company can't get any more senior debt, more sponsor/mgmt equity will lower returns, and so the company looks to plug the funding gap with mezz. As the reatlevel mentioned, the mezz investor will not care as much about exits as PE (although there's usually warrants).
For distressed, basically the investor is usually betting that the face value of the debt will either (a) increase as restructuring becomes more plausible/feasible, or (b) that the securities will be converted to equity - "the fulcrum" - post Ch 11 and the investor thinks that th equity has value post-reorg.
holdco notes/PIK sub notes are just HY bonds, with 100% PIK interest right? so large buyouts use loans (rcf, term loans) for their senior structure and HY bonds for their subordinated structure whereas MM buyouts are similar but instead of HY bonds, they use mezz loans for the subordinated structure?
Perfect.... Thanks for the response. Great insight here and really really appreciate it!
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