alliance mezzanine investors - nyursmith/alliance_mezzanine_case_note.pdf · alliance mezzanine...

Alliance Mezzanine Investors

NYU’s Stern SchoolNYU’s Stern SchoolOctober 31, 2001October 31, 2001

The Creation of a Small Business The Creation of a Small Business Mezzanine Fund Mezzanine Fund

Alliance Mezzanine Investors

Alliance Mezzanine Investors22

AGENDAAGENDA

�� Need + Model = SolutionNeed + Model = Solution�� The SBA ProcessThe SBA Process�� Target MarketsTarget Markets�� How Are We Doing?How Are We Doing?�� Q & AQ & A


THE NEED• Over 50,000 Small Businesses in NY, NJ and PA • Historically, Banks Provided All Outside Capital

–– However, minimum loan sizes have increasedHowever, minimum loan sizes have increased–– Banks require substantial collateral + guaranteesBanks require substantial collateral + guarantees–– Credit ratios must be within Secured Loan limitsCredit ratios must be within Secured Loan limits

• Bank Consolidations Have Reduced Availability of Mezzanine Capital to Small Businesses–– Mezzanine minimums now in excess of $5MMMezzanine minimums now in excess of $5MM

• The Alternative, Venture Capital, is Expensive–– Cost typically > 35%; control always an issueCost typically > 35%; control always an issue


THE OPPORTUNITY• Limited Availability of Growth Capital

High

Cost ofFunds

Low HighAvailability of Funds

Venture Capital@ 30-45%

Working Capital Financing @ 10-20%

Banks@ 8-10%

Mezzanine Debt Opportunity@ 20-27%


THE MODEL

• It Started in 1992 With Dr. Morris and $1 million• In 7 yrs, Sirrom Had a Market Cap of $1 billion • Investment Model was Simple & Straightforward

–– Under $3 million per dealUnder $3 million per deal–– Company growth rates > 20%Company growth rates > 20%–– Sustainable cash flow > 10% of revenuesSustainable cash flow > 10% of revenues–– Outside equity investor / sponsorOutside equity investor / sponsor–– Management a substantial stockholderManagement a substantial stockholder

• Sirrom’s Collapse Did Not Poison the Model


THE SOLUTION

Form an SBICDebentures Only

2 : 1 Leverage

Form an SBICDebentures Only

2 : 1 Leverage ~ 90% Portfolio in Mezzanine Loans

~ 90% Portfolio in Mezzanine Loans

Projected 28 - 30% Net Returns to LPsProjected 28 - 30% Net Returns to LPs

• Private capital of $15 - $20 million

• An “alliance” of banks• Regional network

of similar SBICs• “Regulatory

Legitimacy”• Strict market focus

• Subordinated Debt• Current coupons• Warrants for a

minority interest• All-in Mezzanine

returns of 23%• Equity returns

of 30%

• Assumes 10% losses• 50% current pay• Balance in warrants• Spread lending• Equity level returns

for a Cash Flow risk


THE VALUE PROPOSITION

• Few Mezzanine Players in < $3 Million Space–– Virtually all are Virtually all are SBICs SBICs with mindset to share dealswith mindset to share deals–– AMI is only < $3 million Mezzanine SBIC located in NJAMI is only < $3 million Mezzanine SBIC located in NJ

• SBA Leverage costs ~ 9%; we lend at 23+%

• An Attractive, Yet Scarce Opportunity– 11% - 14% interest + loan amortizations – Warrants to generate an overall return of 22%-27%– Warrant returns realized via “liquidity” Put

• Net Returns to the LPs is 22%-31%– Including a 10% allowance for lossesIncluding a 10% allowance for losses


THE SBA PROCESSTHE SBA PROCESS

•• Raise Minimum of $5 Million Private CapitalRaise Minimum of $5 Million Private Capital–– Start with Friends and Family; slowly expand the circleStart with Friends and Family; slowly expand the circle–– Have an “Institutional” draw (for Have an “Institutional” draw (for SBICs SBICs –– CRA credits)CRA credits)

•• The “MAQ”The “MAQ”–– Is management “qualified” to be entrusted with SBA money?Is management “qualified” to be entrusted with SBA money?–– Direct experience vs. indirect knowDirect experience vs. indirect know--howhow

•• Have a Viable Business PlanHave a Viable Business Plan–– Complement SBA objectives (AMI is the only Complement SBA objectives (AMI is the only Mezz Mezz SBIC in NJ)SBIC in NJ)

•• Invitation for an InterviewInvitation for an Interview–– Meet the people and make your caseMeet the people and make your case


FUNDING THE IDEAFUNDING THE IDEA

•• Individuals for the First $5 MillionIndividuals for the First $5 Million–– Portfolio balancingPortfolio balancing–– Risk adjusted returnsRisk adjusted returns–– Don’t have to hit the “long ball”Don’t have to hit the “long ball”

•• An “Alliance” of BanksAn “Alliance” of Banks–– One in each distinct market areaOne in each distinct market area–– AMI operates as the bank’s Mezzanine affiliateAMI operates as the bank’s Mezzanine affiliate

•• 18 Months, 2 Sets of Tires,18 Months, 2 Sets of Tires, 8 Pairs of Shoes, and 8 Pairs of Shoes, and 23 Packages of Maalox 23 Packages of Maalox


PARTNERSHIP TERMS

• Fund Size: Private Capital: $15.5 M SBA Capital 31.0

Total $46.5 M

• Minimum Size: Institutions: $1.00 M Individuals: $0.25 M

• Term: 10 years

• Management Fees: 2.5%

• Investments of $1 million, with 1% of Private Capital Principals: contributed as GP and balance as LP

• Priority Return 8% compounded, plus a return of capital, to LPs: before profit distributions to the GP


INVESTOR PROJECTIONS• Base Case assumes a Fund size of $30 million, 2 : 1 SBA leverage, a

mezzanine coupon of 12% and warrants to yield an overall mezzanine return of 22.5%, equity returns of 30%, a portfolio consisting of ~90% mezzanine loans, a return of capital and a priority return of 8% to the LPs before distributions to the GP, and an allowance for defaults/losses of 10% of the portfolio value.

• Approximate IRRs to the LPs net of Partnership expenses:

Allowance for Defaults/Losses SBA Leverage 5% 10% 15% 20%

0 : 1 17% 16% 15% 13% 1 : 1 25 23 21 19

2 : 1 31 28 26 22

3 : 1 35 32 29 26


MEZZANINE vs. VENTURE CAPITAL MEZZANINE vs. VENTURE CAPITAL

•• Mezzanine Does Not Require “Grand Slams” Mezzanine Does Not Require “Grand Slams” –– Modest Company Performance = Expected ReturnsModest Company Performance = Expected Returns–– Loss Rate Substantially Less than Private EquityLoss Rate Substantially Less than Private Equity

•• Greater Universe of Attractive Investments Greater Universe of Attractive Investments –– Not Limited to High Growth OpportunitiesNot Limited to High Growth Opportunities–– Premium Pricing at the Downside End Premium Pricing at the Downside End

•• A “Debt” Risk for “Equity” Level Returns A “Debt” Risk for “Equity” Level Returns –– Strictly a Cash Flow analysisStrictly a Cash Flow analysis–– No requirement for an “Exit” eventNo requirement for an “Exit” event


AMI MANAGEMENTAMI MANAGEMENT

•• Bob Eberhardt Bob Eberhardt -- PrincipalPrincipal–– Commercial Banker Experienced in Corporate Credit, Buyout Commercial Banker Experienced in Corporate Credit, Buyout

Finance, Loan Workouts and Financial ControlFinance, Loan Workouts and Financial Control–– Started and Managed Summit Bank’s Mezzanine Finance GroupStarted and Managed Summit Bank’s Mezzanine Finance Group

•• Doug Smith Doug Smith -- PrincipalPrincipal–– Investment Banker Experienced in Corporate Finance, Capital Investment Banker Experienced in Corporate Finance, Capital

Markets, Project Finance, Management Consulting and M&AMarkets, Project Finance, Management Consulting and M&A–– Seasoned Financial and Strategic Advisor to Small BusinessesSeasoned Financial and Strategic Advisor to Small Businesses

•• Steven Fleisig Steven Fleisig -- DirectorDirector–– Investment Banker Experienced in Corporate Finance, M&A, Investment Banker Experienced in Corporate Finance, M&A,

Valuations and Financial AnalysisValuations and Financial Analysis


AMI ADVISORY BOARDAMI ADVISORY BOARD

•• Two Key Individuals w/ Name RecognitionTwo Key Individuals w/ Name Recognition–– Senior Commercial and Investment BankersSenior Commercial and Investment Bankers–– Both broad financial and mezzanine specific experienceBoth broad financial and mezzanine specific experience

•• Our “Alliance” BanksOur “Alliance” Banks–– Experienced credit institutionsExperienced credit institutions–– Familiar with assetFamiliar with asset--based lendingbased lending

•• Our New Best FriendsOur New Best Friends–– 3 Partners in 3 different 3 Partners in 3 different SBICs SBICs in our market areain our market area–– Wealth of experience and recognition within SBAWealth of experience and recognition within SBA–– Informal board with no prescribed duties or responsibilities Informal board with no prescribed duties or responsibilities


TARGET MARKETSTARGET MARKETS

•• NortheastNortheast–– NJ NJ –– NY NY –– PA PA -- CTCT–– New England and Middle Atlantic with coNew England and Middle Atlantic with co--investorsinvestors

•• Borrowers with Sales of $5 Borrowers with Sales of $5 -- $50 Million$50 Million–– History of stable cash flow and profitable growthHistory of stable cash flow and profitable growth–– Proven management team with a significant equity stakeProven management team with a significant equity stake–– Under $3 million for growth or recap purposesUnder $3 million for growth or recap purposes–– Strong market niche or product positionStrong market niche or product position

•• Low Tech and Low Capital Intensity Low Tech and Low Capital Intensity


MEZZANINE STRUCTURE

• 12%-14% Current Pay Coupon• Maximum Maturity of 8 Years • Up to 3 Years Interest Only• Maximum 30% Amortization in Any Year• Warrants for 5% - 20% of Common Stock • Overall IRR of 22%-27%• Warrants Contain Liquidity Put After 5th Year

• Not Expensive Debt … but Cheap Equity!


THE “ALLIANCE” MODEL WORKSTHE “ALLIANCE” MODEL WORKS

•• Slightly Behind Plan, but Fund is Still YoungSlightly Behind Plan, but Fund is Still Young–– As of IIIQ01, 6 deals vs. 10; As of IIIQ01, 6 deals vs. 10; $11M vs. $15M$11M vs. $15M–– Portfolio companies results and prospects look very good Portfolio companies results and prospects look very good

•• Deal Flow Strong From a Variety of SourcesDeal Flow Strong From a Variety of Sources–– Since startup, reviewed 90 deals and committed on 7 Since startup, reviewed 90 deals and committed on 7 –– Five principal sources, with LP Banks being the largestFive principal sources, with LP Banks being the largest–– Most effective source is other Most effective source is other SBICs SBICs (Equity and (Equity and MezzMezz))

•• Under $3M Market Reasonably Well InsulatedUnder $3M Market Reasonably Well Insulated–– Niche markets operate within their own rhythmsNiche markets operate within their own rhythms–– Small Businesses are impacted by overall economic trendsSmall Businesses are impacted by overall economic trends–– On balance, tight credit conditions are good for On balance, tight credit conditions are good for MezzMezz


“SLIDERS” = PRICING ADVANTAGE“SLIDERS” = PRICING ADVANTAGE

•• We Seek “Downside Protection”We Seek “Downside Protection”–– Company Projections Significantly DiscountedCompany Projections Significantly Discounted–– High Warrant Coverage at Low Performance LevelsHigh Warrant Coverage at Low Performance Levels–– Downside Returns Protected ~ 24% IRRDownside Returns Protected ~ 24% IRR

•• And Forego Maximum “Upside Potential” And Forego Maximum “Upside Potential” –– Warrants Reduced as Performance IncreasesWarrants Reduced as Performance Increases–– Limited Returns Beyond ~ 33% IRR Limited Returns Beyond ~ 33% IRR

•• AMI’s AMI’s Standard is Competition’s Reluctance Standard is Competition’s Reluctance –– Warrant Coverage Typically is Single %Warrant Coverage Typically is Single %–– Requires “Agreement” on Future PerformanceRequires “Agreement” on Future Performance


THOUGHTS TO DATETHOUGHTS TO DATE

•• After Slow Start, Now Catching Up to PlanAfter Slow Start, Now Catching Up to Plan–– Plan for 12 deals by yearend; expect to close 8+Plan for 12 deals by yearend; expect to close 8+–– One good quarter and we’re back on PlanOne good quarter and we’re back on Plan

•• Business Model Validated Business Model Validated –– Returns are as expectedReturns are as expected–– Premium pricing availablePremium pricing available–– Borrowers prefer a sliding warrant structureBorrowers prefer a sliding warrant structure

•• Deal Flow Situational; Sources Expanding Deal Flow Situational; Sources Expanding –– Somewhat affected by economic downturnSomewhat affected by economic downturn–– LP Banks continue as best sourceLP Banks continue as best source–– CoCo--investing with other investing with other SBICsSBICs increasing increasing

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