Mezzanine financing question

Question about mezzanine financing:

So, I have this mezzanine financing, coupon payments are 10% cash, 5% PIK and there are warrants for say 10% of equity ownership.

My question relates as to how do I evaluate this deal? What do warrants represent in a typical PE mezzanine deal?

Is it a right to convert some of the loan into equity ownership? If yes, at what rate? I'm not sure I understand what rights a warrant give the mezzanine subordinated debt holder.

Thanks!

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Comments (7)

Jan 6, 2012 - 10:54am

Look up Gordon Tunstall. He speaks around the country to CEO organizations about mezzanine financing and is extremely knowledgeable and respected in the area. There are some videos online I think.

XX
Jan 6, 2012 - 11:12am

I thought warrants were call options separate from the instrument (i.e. you don't have to convert your debt to get the equity. You can just exercise your warrants at a given strike price)

Best Response
Jan 6, 2012 - 11:44am
BCbanker:
I thought warrants were call options separate from the instrument (i.e. you don't have to convert your debt to get the equity. You can just exercise your warrants at a given strike price)

This is correct, at least in all the cases I've seen. It's essentially separate from the debt and the valuation depends on what is agreed upon in the term sheet. Typically they hold no value whatsoever (penny warrants) until they are exercised...which is often triggered by a liquidity event or at your will, if you structured it aggressively.

Typically they are valued based on equity value...something like EBITDA times the purchase/exit multiple, minus the debt and cash on the balance sheet, times whatever your warrant percentage. I suppose this could vary depending how the company wants the debt structured, etc.

If you are building out a model, then the above should be sufficient and hopefully answered your question. If you are being interviewed, it might be worth mentioning how it's important to structure the warrants so you have an option to exit when necessary, with a certain amount of notice. I've seen funds that didn't do that and the payout of the warrants was tied to some very specific event, like the sale of the company or something like that...anyways, the fund was getting toward the end of its life and wanted to exit the investment and the company essentially negotiated a significant discount on the warrants in exchange for voluntarily paying them out...since the company wasn't being sold, or whatever the qualification was in the term sheet.

Hopefully that helps.

Regards

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Jan 6, 2012 - 12:38pm

The only exception that I've ever seen is when the mezz takes the form of convertible preferred.

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Jan 6, 2012 - 1:31pm
Kenny_Powers_CFA:
The only exception that I've ever seen is when the mezz takes the form of convertible preferred.

Yeah. Good call.

Regards

"The trouble with our liberal friends is not that they're ignorant, it's just that they know so much that isn't so." - Ronald Reagan
Jan 14, 2012 - 7:33pm

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