Let's say you are an investor looking at an opportunity to capitalize either mezzanine debt or preferred equity to fund the development of an apartment building which will cost $100m. 65% construction loan, 15% mezz/pref, 20% common equity.
Whether you choose to capitalize preferred equity or mezzanine debt, the interest/pref rate is equal rate and accrue-pay, cash flow distribution priority is equal (fully senior to common equity), and either way you would not participate in the decision making process. Assume standard market-based legal documents with no inter-creditor agreement issues with bank.
Which structure do you choose and why? Thoughts?
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Bump.
mezz, mezz is offering mezz like risk for pref equity return. the pref makes no sense since it's offering mezz like return for pref risk...
This was my initial thought as well, but my boss who runs our fund thinks preferred equity is better all else equal (pref rate, control, priority, etc...) because he thinks the mezz lender is the odd man out if the venture goes to bankruptcy court because the equity partnership is usually the day-to-day manager of project and the senior loan obviously has first cash flow priority.
i don't get this. in a scenario where you end up in bankruptcy court, wouldn't you want to be as high up in the cap stack as possible? what good is decision making equity if it never gets paid out?
I agree this doesn't make any sense. In most cases, aside from hotels, the project company will likely be deemed subject to SARE bankrupcty laws which in effect greatly limit the time to file a plan of reorg and accelerated time to give the creditors relief from automatic stay and thus foreclose immediately. In the latter case if the lender forecloses, the mezz will be paid out 100 cents on the dollar before any equity takes $.01, otherwise that's subject to fraudulent conveyance.
Also bear in mind the mezz lilely has a right of first refusal to purchase the senior at par and thus step into the shoes of the senior and get fully taken out before the equity, and of course if the senior lender loses confidence in mgmt then they can simply waive the standstill and allow the mezz to foreclose on the equity and install new mgmt under the ICA, in either case your equity is fully wiped out.
This is really a discussion for your BK counsel as these rules are subject to state BK laws in the jurisdiction of venue, my comments above are just what you can expect to see generally.
A mez without an intercreditor is essentially a hard pref which can sometimes be more onerous then mezz depending on how its written. I have seen deals where the pref holds the share until its paid back effectively a buy back clause and controlling interest can be taken away if certain conditions are not met.
You want the financing that offers the least amount of control i.e. likely debt so mezz
I disagree with this. Pref ranges from more equity like pref (like common, just a preferred return) or debt like pref. The debt like pref has control rights or events that could trigger defaults/replacement of manager etc.
OK, so this is what I wanted to get at. Is the equity manager replacement provisions or debt default process quicker and more full-proof? I'm looking at this worst-case scenario as in what happens if the project cannot service the debt and/or goes into bankruptcy.
Mezz means you control everything, but with pref you have less risk since its essentially just equity.
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