Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
by Jim Martyka Once, not so long ago, this land was filled with angel investors, ready to open up their wings, share their wealth and help small businesses of all varieties soar.
And if it wasn’t an angel with a fat wallet or purse, it was a group of saints — venture capitalists who proclaimed to anyone listening they had money to give. The possibilities were endless and the opportunities plentiful.
Now the angels are in hiding. The saints are hoarding the collection plates. And paradise has given way to an economic downturn, less available capital, stingier bank loans, equity markets in turmoil.
“Today money is harder to find than ever before. You’ve got to dig in the dirt to find cash, and digging in the dirt is not a fun thing to do,” says Peter Lytle, managing partner of the Business Development Group in Wayzata.
He says that few companies’ growth plans today are funded with one source of money. Instead, a complex combination of funding will get companies to their magic number.
What follows is a primer on how to get some of the lesser known forms of financing, a glossary to most of the types available, and advice from a banker on making the cash you’ve got last as long as possible.
Mezzanine lending
One form of financing that rears its head in harsher times is mezzanine lending. Most companies like to avoid it when times are good, but with capital markets in their current state, mezzanine lending is becoming a top option for many small businesses.
“It’s never a first choice for any firm, but in times like these it can become a necessary evil,” says Jon Goetze, owner of Minneapolis-based Capital Solutions. Capital Solutions is a corporate financing firm that represents buyers and sellers in transactions, from arranging the financing to helping with the transition.
He has helped many firms with mezzanine lending and says he is seeing an increase now. “Small businesses don’t have as many options and quite honestly, transactions and growth won’t get done unless this type of lending is brought to the table, at least for now.”
On one end of the lending spectrum lies senior lending or debt financing, which comes in the form of standard bank loans with interest rates and terms that most business owners know. On the other end is equity investing, which gives investors ownership stakes in the firm that’s being funded. Mezzanine lending falls somewhere in the middle, in terms of the amount companies can borrow, the structure of the deals and the risk.
‘Meat in the sandwich’
While all mezzanine deals are structured differently based on individual needs, the most common come in the form of a loan, similar to that of a bank loan, only at a much higher interest rate. The second component, and the largest distinguishing feature of a mezzanine loan, is that it often also involves a small equity stake for the lender.
“It’s the meat in the sandwich,” says Stephen Lewis, senior vice president of Medallion Capital in Burnsville. Lewis and his firm deal primarily in mezzanine lending and he says business is growing as small firms look to fill their plates. “Mezzanine lending combines and falls in between the two extremes. But it is a source of funding that helps companies get the total amount they need to do what they want to do.”
Today, there are a handful of local mezzanine lending firms that work with companies of all sizes. A slower economy means business is growing.
“Mezzanine lending provides a simple model for a lot of these companies in that the structure of the deals isn’t very complex and they provide a quick solution,” says John Mason, managing partner at Convergent Capital Partners in Minneapolis, a mezzanine lender.
“Essentially, this type of financing works for companies in just about all industries,” he says. “The companies that are looking for these types of loans are companies that are looking for expansion capital, recapitalization if they’re not getting enough from a standard bank loan, and money for a buyout.”
Providing a bridge
A buyout the case for Digital Excellence, a multi-media manufacturer in St. Paul. When the low eight-figure company was going through a buyout last year, the new owners needed some extra capital for the acquisition. After they got some loans from the bank, they pursued a mezzanine loan to make up another 20 percent of the purchase price.
“We needed it to get the deal done and to get it done quickly and the mezzanine loan allowed us to do that,” says Don Major, chief financial officer for the firm. “It provided the bridge between what the bank was willing to provide and the costs we had to cover.”
Major said the mezzanine loan also provided the company with more flexibility, plus added resources because the lending firm, which received an equity stake, had more interest in the success of the firm and thus, their return.
Mezzanine flexibility comes from the fact that lenders are often more willing to put up more cash than most regular bankers. Plus, experts say, history has shown that mezzanine lenders will usually get deals done more quickly than banks, with a lot less reporting that standard loans require, since the banks have already done most of the due diligence.
Goetze mentioned an example of a local firm that was going out of business quickly as it was rapidly losing money. When another company wanted to buy the firm, it couldn’t get a loan from the bank quickly enough. “But a mezzanine lender got the deal done quickly and that allowed for the company to be saved,” Goetze says. “And we see that a lot.”
But mezzanine loans, while helpful to many small firms, have their drawbacks.
Interest rates run about 12 percent to 14 percent, which is is a much higher percentage than a standard bank loan, which is hovering around 5 to 7 percent. (However, it is much less than a full-blown equity stake, which could mean sacrificing a large chunk or even a majority of the company, assuming the company could even find a party interested in an equity stake).
“These companies should always try the banks first because they can get cheaper money,” says Robert Tunheim, an attorney with Minneapolis-based Lindquist & Vennum. “Mezzanine loans can get expensive and that’s not the best way for a company to start. They should look to mezzanine lending when the bank loans don’t cover what they need.”
And then there is the issue of the equity stake. This stake typically comes in the form of warrants due at the end of a loan term (a warrant is the right to buy stock in the company at a set price and time). Most mezzanine financing requires the borrower to buy back the warrants at the end of the loan, thus providing additional interest to the lender. But in the meantime, the lender has a stake in the company and will often structure financing in a way that will most help the borrower and its value over time. However, this also means that the borrower is giving up a piece of the firm (and thus some of the profits).
But lending officials say they have a tendency to let the businesses run themselves while they simply provide support.
“Companies need to go into this type of lending with their eyes open,” Lewis says. “Companies will always look at bank loans first. And they should never get these loans to cover past debts because it is expensive money. Instead, mezzanine lending should be used to help companies grow.”
As far as the equity stake, Lewis says that is rarely an issue.
“I guess if you have a problem with sharing, you will have a problem with these kinds of loans,” he says. “But chances are, if your company is making money, you won’t have much of a problem with that. And mezzanine loans can help put you in that position.”
sl****@**************al.com. Peter Lytle, The Business Development Group: 952.473.3831. Don Major, Digital Excellence: 651.772.5186; dm****@**gx.com. Jon Mason: Convergent Capital Partners: 952.595.8022; jm****@***ap.com. Robert Tunheim, Lindquist & Vennum: 612.371.3915; rt******@*******st.com
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