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The Basics of Mezzanine Finance

Quick Facts

Usage

Mezzanine Finance is generally used in combination with an acquisition, restructuring, or other transactions, to bridge the gap between the total purchase price and the equity and senior debt that’s available.

Costs

High interest rates, mid teens up to the low twenties, including an equity component

Term

3-5 years, often with yield protection

Seeking Mezzanine Finance? Let’s discuss how we can help. ►

Overview

Mezzanine Finance is indebtedness that’s junior to the senior indebtedness but is senior to equity. Mezzanine Finance is usually employed in connection with transactions where senior lenders won’t provide the full amount of financing, and there’s a gap between the amount of equity and senior that can be provided and the ultimate purchase price.

Mezzanine Finance is characterized by high interest rates, from the mid teens up to the low twenties, including an equity component generally in the form of warrants or stock.

The term is typically three to five years in duration. Many mezzanine loans come with what’s known as yield protection which provides that during the first several years it’s not permitted to be repaid unless the full amount of interest that would otherwise be payable during that period of time is also paid with prepayment.

Mezzanine Finance is ordinarily used in the context of transactions such as mergers or acquisitions, restructurings, or other transactions to bridge the gap between the total purchase price and the equity and senior debt that’s available.

There are many mezzanine firms, which range from family offices to private equity related firms and specialty credit funds. They are all characterized by those higher interest rates and the same types of provisions and equity coverage.

Let’s discuss how we can assist you with your Mezzanine Finance. Get in touch with our team below.

How to Build a Virtual Data Room

When contemplating financial, corporate, or M&A transactions, it is important to have a comprehensive data room in place. Any potential partners, whether investors, merger partners, or strategic partners will want to review all of the company’s documentation relating to their corporate structure, operations, and financings.

The Steps to Building a Virtual Data Room

Step 1: Find a Data Room Provider

There are many data room providers out there. Some of the important differentiating attributes to consider are:

  • Permissioning: most data room providers allow permissioning, with which you can grant different file access to different individuals. This can be useful if you have multiple types of potential partners accessing the data room at the same time. Most platforms can also limit file downloads so that certain people can only view files on the web, not download.
  • Auditability: it can be very helpful to know who is looking at what files, for how long, and how often. This can help you gauge the interest of potential partners. For example, partner A may tell you they are interested in pursuing a relationship but they’ve only looked at three files and only logged in once, while partner B may have logged in numerous times and looked at every file in the data room.
  • Pricing: pricing can vary dramatically between platforms. Some platforms charge flat fees while others charge per user.
  • User Interface: the user interface can affect how potential partners view the process of conducting due diligence on your company. If the interface is slow, it may cause potential partners to fatigue of the process. Additionally, it may be important to choose a platform where users granted access to the data room cannot see who else has been granted access.
  • Storage/File Size/File Type Limitations:some data room providers have very strict limitations on the file types and file sizes allowed as well as the total amount of storage available. It is important to understand these limitations prior to selecting a platform.

Here is a list of some of the top rated data room providers from G2 Crowd.

Step 2: Determine Data Room Structure

Having a cohesive data room folder structure can make the process of conducing due diligence much easier. This is the structure we use for our clients’ data rooms:

  • Corporate Documents and Corporate Matters
  • Securities and Securities Matters
  • Financing Documents
  • Properties/Leases/Insurance
  • Intellectual Property; Rights and Permits
  • Other Contracts/Agreements
  • Products and Inventories
  • Regulatory Documents/Litigation
  • Employees and Consultants
  • Financial Information
  • Environmental Matters
  • Miscellaneous

Building a data room? Download our full due diligence list here. This due diligence list is in the form generally used by investment banks, private equity firms, venture capital firms, family offices, strategic partners, and M&A partners.

Step 3: Upload and Organize Files

When uploading files, you should rename files so the user knows what the file is without having to review it. For example, documents with names like “scan” and dates should be renamed to the actual file type. Additionally, consistent filing nomenclature and format should be used.

Text-based documents should be uploaded as PDFs which makes them easier to view. Financial documents should be uploaded as Excel files when applicable. This allows data room users to manipulate numbers to see how changing variables affects financials.

Step 4: Grant and Monitor Access

Once your data room is built, you are ready to grant access to users. Make sure you pay close attention to the permission settings for each user.

If your platform has auditability features, check frequently to see how active users are and what files they are viewing most. If you see that many users are accessing the same files multiple times, these may be critical files or they may have issues.

Let’s discuss how we can guide you through your transaction. Get in touch with our team below.

State of M&A: Q3 2019

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5 Things To Ask Potential Investors

When taking in a capital partner, people tend to focus most on the amount of money the partner is investing into the company and the valuation. While these are both important things to consider, there are many other things a company should ask potential capital partners.

Ask your potential investors these five questions

How involved do you like to be in your portfolio companies?

A capital partner’s involvement in a company can vary dramatically. Venture and private equity firms tend to be highly governance-focused, which means that they impose substantial limitations on management autonomy and have substantial additional consent and other rights. Some capital partners want to know every detail of a company’s business with updates multiple times a week, while others want an update once a quarter.

Our experience has been that family offices generally tend be less focused upon governance and want to be kept current on company progress, but prefer not to assume operational or board roles within their investments.

Generally, we prefer to match companies with capital partners that do not desire to be actively involved in the company’s operations. When we work with a company, we do so because we believe that the company’s management team has the ability to lead the company to success. Partners should be able to provide advice when requested, but should not interfere with a company’s ability to execute.

What is your history of conversion vs repayment?

Many capital partners prefer to structure growth capital transactions as convertible notes, rather than straight equity. A convertible note is debt with the option on the part of the investor to convert the debt into equity.

Investors look at convertible notes two different ways. The first group looks at convertible notes as essentially an equity investment with protections in the case that things should not go as planned. The second group look at convertible notes as a loan to the company, with the ability to take advantage of the upside if they should choose to do so.

It is important to understand a capital partner’s plans relating to conversion so as to give the company the opportunity to plan for repayment or equity dilution.

How important is a liquidity event and when?

Liquidity events are events in which company holders have the ability to sell or otherwise capitalize on the value escalation of their position in the company. The two most common liquidity events are public offerings and acquisitions, although contractual liquidity events, such as redemptions, as common as well.

Depending on the capital partner, a realistic plan for a liquidity event may be very important. From the investor’s perspective, their biggest fear is becoming a captive minority holder of equity in your company.

For example, an investor can purchase equity in a company, only to have the management team pay themselves higher and higher salaries, with no plan for a liquidity event. As a result, the capital partner is left with a lost investment and no return.

Do you engage in a lot of litigation?

It is not uncommon for emerging and middle market companies to experience delays when either repaying debt obligations or paying redemption prices. Growth requires substantial capital and many companies inaccurately budget for these events.

Most capital partners are understanding, to a degree, and will afford their portfolio companies leniency as to timing; others have no tolerance for delays and are quick to assert their rights. While many companies would accuse the latter group of “not being team players”, it is an unfair characterization as investors are entities to the benefit of the terms of their investment.

Understanding the character of your capital partners and their history, as well as proper planning and budgeting, can spare you a great deal of angst when payment deadlines are approaching.

What management positions have you held and boards of directors have you served on?

An investor’s past experience can be very valuable to a company. Many times, capital partners have past experience running and growing their own companies or companies.

Whether or not their past experience is in a similar industry to the company in which they are investing, having someone else with experience on a company’s team can help with strategic decisions. An investor can also provide access to influencers, clients, supply chain partners, and additional capital.

Wondering what is best for your company? We are always happy to discuss the funding and growth options available to a company. Get in touch with our team below.

State of M&A: 2018

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The Venture Capital Reality: Is It The Right Path To Capital?

The Myth

For many years, the dream of receiving financing from a venture capital firm, whether from Silicon Valley, New York, or elsewhere, has captivated entrepreneurs and has been one of their central focuses. The image of plentiful venture capital readily available to creative entrepreneurs has been cultivated by the industry itself, as well as by the media. In reality, the image is a mirage or myth.

According to the American Venture Capital Association, the NVCA, in 2017, venture capital firms deployed an aggregate of $84.2 billion into 7,783 companies. While this fact on its face appears impressive, this represented the lowest number of companies since 2012 and includes both initial investments and follow-on investments. Indeed, the NVCA notes that overall there were fewer transactions taking place, that consummated transactions were at higher values and that companies were later stage, e.g., more mature. Specifically, 2017 saw a 6% decrease in terms of aggregate deals over 2016, yet a surge in total deal value of 16% year over year.

The Reality

Start-Up.co reports that 565,000 start-up companies are launched monthly in the United States and that the average funding of these companies is $78,406, resulting in aggregate funding, whether seed, early, growth, or late stage, and irrespective of funding source, of $531 billion per annum. Startupshepherd.com estimates that, of these companies, only 1,400 per year receive funding from venture capital firms. For purposes of illustration only, based on the foregoing, if we assume that 90% of all start-up companies in a given year would for various reasons be ineligible for venture capital investment, venture capital firms would still only be financing approximately 0.2% of eligible start-up companies in any given year. Indeed, Forbes.com notes that “Less than 1% of startup businesses actually get their financing from VCs or angels.”

Even with respect to the firms that do receive venture capital investment, the question should be “Why are you raising venture capital in the first place, instead of another capital structure?” Forbes.com

Nothing mentioned in this post is intended to be offensive to venture capital firms. ClearThink maintains active relationships with many firms and has advised numerous clients with respect to venture capital transactions. That being said, all entrepreneurs (ourselves at ClearThink included) need to recognize and plan for the reality that, in all likelihood, venture capital will not be in their future.

So …

The companies not financed by venture capital firms are obtaining capital from somewhere. But where?

  • Friends and Family
  • Angel Investors
  • Crowdfunding
  • Strategic Investors
  • Private Equity Firms
  • Investment Banks
  • Alternative Commercial Credit

Each of these capital sources have distinct advantages and disadvantages.

Non-Venture Fund Sources of Capital

Family and Friends

Family and friends tend to be the least sensitive to valuation and investment terms and tend to be the most patient. That being said, failure of an investment to succeed can result in some awkward family and social gatherings.

Angel Investors

Angels tend to be “accredited investors” under the Federal securities laws and provide capital and expertise to early stage companies. FundersandFounders.com estimates that the U.S. angel investor universe is approximately $21 billion, and that the average investment is approximately $37,000, as opposed to approximately $7.5 million for venture capital firms. As a result, angel investors make investments into far more companies annually than do venture capital firms. Score.org estimated that in 2014 there were approximately 268,000 angel investors in the United States.

Crowdfunding

Crowdfunding is a relatively recent structure created by the JOBS Act in 2012. In short, crowdfunding contemplates small investments by large numbers of generally unsophisticated individuals. According to the Securities and Exchange Commission, or SEC:

“With Regulation Crowdfunding, the general public now has the opportunity to participate in the early capital raising activities of start-up and early-stage businesses. Anyone can invest in a Regulation Crowdfunding offering. Because of the risks involved with this type of investing, however, you are limited in how much you can invest during any 12-month period in these transactions. The limitation on how much you can invest depends on your net worth and annual income.”

Crowdfunding has had a lackluster history to date. Based on the SEC’s whitepaper, of 187 crowdfundings conducted, 24 were withdrawn. The remaining 163 sought to raise an aggregate of $101.1 million, but raised in the aggregate only $8.1 million or 8% of the amount sought. Further, of 104 crowdfunding offerings with terminal dates during 2016, 18 were withdrawn and only 33% raised their minimum target amounts.

As a result of the large number of resulting stockholders following a successful crowdfunding, companies availing themselves of crowdfunding have experienced substantial difficulty in raising additional capital in subsequent rounds, and institutional investors have tended to shun companies which have raised money through crowdfunding. In addition, as crowdfunding investors are generally unsophisticated, valuations utilized in crowdfundings have tended to be over-inflated, resulting in substantial down-rounds subsequently, which has the potential to result in investor resentment and potentially litigation.

Strategic Investors

Strategic investors are companies in the same or related industries or markets to the company seeking capital. Transactions are often structured to establish an ongoing business relationship between the investor and the recipient of the capital and have tended to have higher valuations than pure venture financing, especially reflecting adjustment provisions built into venture capital documents.

Private Equity Firms

Certain companies will appeal to private equity firms. Private equity is similar to venture capital, but focuses on later stage companies and can seek to provide control investments, minority investments, growth capital and other structures.

Investment Banks

Investment banking firms aggressively seek emerging growth companies in search of financing. Depending upon, among other things, the company, its industry, and market conditions, transactions can be structured either as a private offering or a public offering, and can range from convertible debt securities to pure equity. These offerings are highly regulated, although institutional interest for the right company and the right transaction remain high, and certain funds, known as transitional capital funds, have specialized in providing private capital to companies seeking public offerings in the near future.

Alternative Commercial Credit

For companies which qualify, there is a large community of family offices and funds which specialize in the provision of commercial credit to companies which would not otherwise qualify for bank financing. These firms can be creative in structuring lines of credit, asset-backed lines, purchase order financing, equipment financing, and other forms of commercial credit.

Is raising capital in your future? Let’s discuss how we can be helpful. Get in touch with our team below.

What is Due Diligence?

Perhaps the most important aspect of any corporate transaction, whether a private offering of securities, a public offering, a merger or acquisition or otherwise, is what is known as “due diligence”.

“Diligence is the mother of good fortune.” – Benjamin Disraeli

The Basics of Due Diligence

Due diligence requires the review of all material documents and other information with respect to a company in order to ensure that any disclosures which a company makes, whether in offering materials or an agreement, are true and correct and satisfies any applicable standard of liability.

What does “material” mean?

The Supreme Court has held that something is “material” if there is a substantial likelihood that it would be deemed important by a reasonable investor in making a decision to purchase or sell a company or its stock or as to how to vote their shares.

A due diligence review will inform you as to the material attributes of a company or person, including their commitments, contracts, and liabilities, their business, prospects, financial condition, and results of operations.

  • Does the company exist?
  • Who are the owners?
  • How does the business work?
  • Who are its customers?
  • How do you know that a company has the contracts it claims?
  • How do you know if the projected financial results are based upon accurate and reasonable assumptions?
  • What are the liabilities or contingencies?
  • The answer to these questions, as well as many more, lies with effective due diligence.

Due Diligence for Public and Private Securities Offerings

Securities offerings are governed federally by the Securities Act of 1933, as amended. Pursuant to Section 11 of such Act, as a general matter, if any disclosure with respect to an offering of securities contains an untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make the statements therein not misleading, the issuer of such securities, the officers and directors of the issuer, partners in the issuer, the investment bankers conducting such offering, and professionals retained by the issuer with respect to such offering, are subject to liable for such material misstatements or omissions.

While there are no defenses to the foregoing available to the issuer and only limited defenses available to the members of the board or executive officers of the issuer, the other parties listed above may rely upon what is known as the “due diligence defense”.

The Act provides that it shall be a defense to such liability if such other party had, after reasonable investigation, e.g., a “due diligence review”, reasonable grounds to believe and did believe that the statements in such disclosure were true and that there were no omissions to state a material fact required to be stated therein or necessary to make the statements therein not misleading.

Due Diligence for Mergers and Acquisitions

In the context of mergers and acquisitions, due diligence serves the role of fact finding, disclosure checking, and confirmation, e.g., that the representations and warranties set forth in the operative transaction documents are true and correct.

While the standard of liability in this context can be modified by contract, a due diligence review ensures that the purchaser or purchasers are receiving what they believe to be correct.

Importance of Due Diligence

The failure to engage in a complete and effective due diligence process can be catastrophic and result in substantial litigation.

Below is a list describing some of the greatest due diligence failures of all times and some of the consequences that resulted.

ClearThink Capital’s Due Diligence Process

Any due diligence process is based upon organization: the company subject to the review will need to organize its material documents and descriptions of undocumented material facts so as to provide full disclosure in all material respects.

Although most companies can accomplish this process with little disruption, companies that have not kept complete and organized records and documents may be required to dedicate substantial time to establishing an organization process and adhering to the process.

ClearThink seeks to make the due diligence as easy and simple as possible and provides a form of initial due diligence request list that reflects the organization expected by transaction participants and provides a structure for the categorization of documents.

In order to expedite the transaction process and assure full disclosure, ClearThink does the following:

  • Dataroom: ClearThink will establish for each transaction an organized dataroom in the form expected by the transaction participants and corresponding to our initial due diligence request list.  ClearThink reviews and remediates the due diligence of its client in advance of disclosure to others
  • Report: ClearThink will review all due diligence materials provided by its client, as well as other parties to the contemplated transaction, will document its review, and will make suggestions regarding, and endeavor to assist with, remediation, amendments, or explanation required in order to provide full, fair and accurate disclosure
  • Gatekeeping: ClearThink will act as the gatekeeper to the dataroom, providing access only with the consent of the relevant parties, thereby minimizing the possibility of the compromise of sensitive data

As a philosophical matter, ClearThink is a strong proponent of full disclosure of both positive and negative information.  That being said, proper management of the due diligence process will assure that corrective measures are completed prior to disclosure to third parties, thereby maximizing the probability of a successful transaction.

ClearThink and its principals have extensive experience in the management of due diligence reviews, including reviews relating to 240 public offerings raising an aggregate of $9 billion of public debt and $6 billion of public equity for companies such as The News Corporation Limited, Fox, Comcast, TCI Communications, British Sky Broadcasting, and Liberty Media, among others, as well billions of dollars of mergers and acquisitions.

Planning a corporate or financial transaction? Let’s discuss how we can be helpful. Get in touch with our team below.

Valuing SaaS Companies

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