Mezzanine Finance: What exactly do you do here?

Anyone who has taken a basic corporate finance class has probably run across the ambiguous term of junior debt. But what exactly does that mean and who exactly are the people working in the trenches. I had the opportunity to work with one of the more successful middle market mezzanine finance firms in the greater philadelphia/delaware/new jersey area and figured I'd provide some insight to try and help pay back all of the lurking I did over the past year and a half.

So to start with the basics, why do people even use mezzanine financing and how does it work? The most basic form of a capital structure within a company generally goes senior debt, junior debt, and equity. Senior debt is pretty well known; a large bank (TD, PNC, BoA, etc.) is willing to lend at modest rates in return for a first claim on hard assets (inventory, equipment, property, contracts). Banks tend to be very careful lenders though. The other common route for generating cash to grow your business is by raising equity. However, there becomes a certain point when the bank has no more assets to lend against and you don't want to dilute your equity any further (especially when EBITDA is $5-$10MM).

Mezzanine financing comes in at this junction then. Most loans are made with a 12-14% coupon, and some combination of an equity buy-in, PIKing, or warrants. Many smaller mezzanine finance firms are SBIAs, which means that they get part of their funding from the government (a large portion is still high net worth individuals and institutional investors) so long as they only lend to companies that meet certain requirements (in the US, where employees are, etc.).

With that basic outline, here are a few general questions that I think will come up so I'll do my best to answer them now:

Who works in the industry?

From what I've seen, the industry tends to be dominated by former senior lenders with investment bankers and corporate management types sprinkled in. Because Mezzanine lending focuses on the credit perspective, it's not too surprising that commercial lenders tend to transition into the space.

How do funds make money?

The 12-14% interest rates on loans are not high enough for funds to be successful. The extra money that makes a good firm profitable usually comes from identifying good portfolio candidates who will grow at a steady rate. The two main ways of benefiting from a company's success are through equity co-investments and warrants. Generally, equity co-investing is standard procedure when a company has demonstrated the ability to grow consistently and is a lower "risk". Warrants are essentially free upside in the equity of a company and are used when a company's credit profile might be weaker.

What are the hours like?

Generally very reasonable. Interning, I was putting in about 40-50 hours a week. Although the fund was small, I'd say everyone else was putting in about 10-11 hour days during the week with a few additional hours (maybe 3-5ish) on the weekend. Obviously hours depend with deal flow, but I'd say that's standard in this line of work.

What will I make?

As a lowly intern in a very small firm, I didn't have the cojones to probe people who could be my parents/grandparents on what they make. I have met people who came from BB banking programs as associates and work in the industry, so comp has to be competitive. Maybe someone else can chime in on this for me.

Will I get to flew my excel modeling muscles?

Yea buddy!

Will I be making powerpoints?

Hell no!

Feel free to let me know if you have any other questions and hopefully this was a useful primer.