mezzanine financing: legal considerations for...

Mezzanine Financing: Legal Considerations for Middle Market Deals Evaluating and Structuring Financing for Acquisitions, LBOs, Expansions, Recapitalizations, and Management Buyouts

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TUESDAY, FEBRUARY 21, 2012

Presenting a live 90-minute webinar with interactive Q&A

Charles J. Morton, Jr., Partner, Venable, Baltimore

Andrew Trigg, Managing Director, Graycliff Partners, New York

Ronald W. Kerdasha, Jr., Group Senior Vice President/Region Executive, Cole Taylor Business Capital, Baltimore

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5

Mezzanine Financing: Legal Considerations for Middle Market Deals Evaluating and Structuring Financing for Acquisitions, LBOs, Expansions, Recapitalizations, and Management Buyouts

FEBRUARY 13, 2012

6

© 2012 Venable LLP

Meet the Speakers

Andrew P. Trigg Managing Director, Graycliff Partners [email protected] Ron Kerdasha Group Senior Vice President/Region Executive Cole Taylor Business Capital [email protected]

Charles Morton Partner, Venable LLP [email protected]

www.Venable.com

mailto:[email protected]�



7

LBO Purchase Price Multiple and Equity Contribution Middle Market

Purchase Price Multiple

7.6 7.5 7.1 6.95.9

6.7 7.0 7.28.5 8.1

9.38.3

6.6

8.47.8

8.9

0x

5x

10x

15x19

97

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

YT

D 3

Q11

3Q11

Senior Debt/EBITDA Sub Debt/EBITDA Equity/EBITDA Others

Equity Contribution

0%

10%

20%

30%

40%

50%

1997

1999

2001

2003

2005

2007

2009

YTD 3Q

11

All Financial Data provided by Standard & Poor’s

8

Average Debt Multiples of Middle-Market LBO Loans

4.8 4.7

4.1 4.0

3.43.9 3.8

4.24.7 4.7

5.6

4.5

3.3

4.2 4.24.6

0.0x

2.0x

4.0x

6.0x

8.0x

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1Q-3

Q113Q

11

FLD/EBITDA SLD/EBITDA Other Sr Debt/EBITDA Sub Debt/EBITDA

9

Average Pro Forma Credit Statistics for Middle-Market LBO Transactions

10

Average Pro Forma Credit Statistics for LBO Transactions

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1/1-9/30/11 3Q11Debt/EBITDA 4.96 4.85 4.30 4.09 3.52 3.93 4.10 4.57 5.01 5.12 6.05 4.77 3.69 4.55 4.86 5.03Senior Secured Debt/EBITDA 3.64 3.51 3.40 3.24 2.69 2.91 2.88 3.35 4.09 4.41 5.42 4.00 3.19 4.04 4.61 4.74EBITDA/Cash Interest 2.55 2.43 2.79 2.48 3.29 3.74 3.50 3.48 2.72 2.46 2.10 2.75 2.81 3.11 3.31 2.70EBITDA - Mainten. Capex/ Interest 2.05 2.04 2.28 2.10 2.72 3.25 3.03 2.97 2.33 2.03 1.74 2.38 2.62 2.65 2.83 2.43EBITDA - Capex/ Interest 1.75 1.76 2.03 1.93 2.47 3.05 2.90 2.77 2.12 1.95 1.68 2.24 2.62 2.49 2.65 2.21

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1/1-9/30/11 3Q11Debt/EBITDA 5.30 5.15 4.74 4.30 3.70 4.07 4.38 4.90 5.37 5.74 6.63 5.09 3.81 4.70 5.09 5.03

Senior Secured Debt/EBITDA 3.34 3.07 3.18 3.05 2.47 2.48 2.72 3.05 3.56 3.98 4.99 3.39 2.90 3.35 4.15 3.94EBITDA/Cash Interest 2.18 2.32 2.33 2.25 2.92 3.34 3.14 3.01 2.38 2.12 1.77 2.29 NA 2.56 3.19 2.53

EBITDA - Mainten. Capex/ Interest 1.84 1.95 2.01 1.89 2.43 3.00 2.71 2.43 1.98 1.84 1.46 2.11 NA 2.25 2.40 2.17EBITDA - Capex/ Interest 1.61 1.62 1.77 1.73 2.12 2.78 2.58 2.59 1.92 1.76 1.44 2.02 NA 2.13 2.30 1.85

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1/1-9/30/11 3Q11Debt/EBITDA 4.38 4.30 3.71 3.66 3.17 3.68 3.33 4.01 4.66 4.71 5.69 4.51 3.53 4.47 4.78 5.03Senior Secured Debt/EBITDA 4.38 4.19 3.61 3.63 3.10 3.68 3.33 3.89 4.61 4.69 5.69 4.51 3.53 4.47 4.78 5.03EBITDA/Cash Interest 2.86 2.87 3.27 2.97 4.06 4.43 4.52 4.43 3.11 2.66 2.30 3.21 NA 3.40 3.36 2.74EBITDA - Mainten. Capex/ Interest 2.37 2.39 2.65 2.56 3.36 3.68 3.94 3.48 2.73 2.28 1.92 2.64 NA 2.86 2.98 2.50EBITDA - Capex/ Interest 1.75 1.76 2.03 1.93 2.47 3.05 2.90 2.77 2.12 1.95 1.68 2.43 NA 2.68 2.76 2.29

All LBO

With Sub Debt

Without Sub Debt

11


5.034.74

2.72.43

2.21

5.03

3.94

2.532.17

1.85

5.03 5.03

2.742.5

2.29

0.0x

2.0x

4.0x

6.0x

8.0x

Debt/EBITDA Senior SecuredDebt/EBITDA

EBITDA/CashInterest

EBITDA - Mainten.Capex/ Interest

EBITDA - Capex/Interest

All LBOs (Observations: 24) LBOs with Sub Debt (8) LBOs with no Sub Debt (16)

12


4.864.61

3.312.83 2.65

5.09

4.15

3.19

2.4 2.3

4.78 4.78

3.362.98

2.76

0.0x

2.0x

4.0x

6.0x

8.0x

Debt/EBITDA Senior SecuredDebt/EBITDA

EBITDA/CashInterest

EBITDA - Mainten.Capex/ Interest

EBITDA - Capex/Interest

All LBOs (Observations: 73) LBOs with Sub Debt (20) LBOs with no Sub Debt (53)

13

Equity Contribution to Leverage Buyouts

7.0%9.7%

13.4%

20.7%22.0%25.2%26.2%

23.7%22.9%

30.0%31.7%

35.7%37.8%

40.6%40.0%39.5%

35.1%32.1%33.6%32.9%

42.6%

50.8%

43.8%41.3%39.2%

0%

25%

50%

75%

1987

1988

1989

1990

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

YTD 3Q

113Q

11

Rollover Equity Contributed Equity

14

Sources of Proceeds - All

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Bank Debt 47.88% 47.91% 44.09% 43.65% 37.29% 43.70% 49.39% 51.24% 53.31% 39.10% 33.08% 41.58% 43.33%Secured Debt 1.13% 0.49% 0.96% 0.00% 0.00% 1.01% 2.14% 3.18% 1.73% 2.43% 0.03% 1.25% 0.00%Sr Unsec'd Debt 0.16% 0.45% 0.00% 0.00% 0.00% 2.50% 4.22% 3.07% 5.07% 6.07% 4.67% 5.85% 9.58%Public/144a High Yield 5.36% 1.80% 3.80% 6.29% 11.85% 9.94% 6.17% 3.33% 3.54% 1.78% 1.95% 0.74% 0.98%Bridge Loan 2.50% 1.40% 2.68% 2.52% 0.33% 0.63% 1.32% 0.53% 0.35% 0.41% 4.67% 0.29% 0.00%Mezzanine 4.72% 8.24% 5.81% 3.74% 4.95% 4.13% 3.19% 4.12% 1.80% 6.32% 7.08% 5.09% 1.24%HoldCo Debt / Seller Note 3.10% 1.99% 4.43% 3.15% 1.59% 1.17% 0.82% 0.44% 0.35% 0.42% 0.00% 0.47% 0.12%Preferred Equity 8.46% 8.78% 6.82% 6.81% 4.93% 2.61% 0.87% 0.23% 0.07% 0.00% 0.00% 0.87% 0.00%Common Equity 20.06% 23.17% 23.79% 27.36% 28.26% 28.78% 28.14% 30.40% 30.45% 38.44% 45.51% 40.02% 38.32%Rollover Equity 4.10% 3.89% 5.53% 2.67% 4.66% 2.70% 2.29% 2.49% 2.05% 3.76% 5.09% 2.39% 2.03%Other 2.52% 1.95% 2.22% 3.80% 6.13% 3.42% 1.44% 0.96% 1.30% 1.28% 2.16% 1.45% 4.39%

Total Senior Debt 49.17% 48.85% 45.06% 43.65% 37.29% 47.22% 55.75% 57.49% 60.10% 47.60% 37.78% 48.68% 52.91%Total Sub Debt 12.58% 11.44% 12.29% 12.55% 17.13% 14.71% 10.68% 7.98% 5.69% 8.51% 13.70% 6.12% 2.22%Total Equity 35.72% 37.83% 40.57% 39.99% 39.44% 35.27% 32.12% 33.56% 32.91% 42.62% 50.61% 43.76% 40.47%Average Loan Size $173.3M $199.7M $194.8M $261.6M $300.3M $354.0M $417.7M $458.8M $540.1M $454.0M $251.1M $413.9M $391.7MAverage Sources $316.6M $351.2M $388.6M $540.3M $716.3M $706.1M $972.4M $1308.8M $2095.0M $1731.9M $639.6M $1014.4M $1019.0MObservations 133 116 51 40 66 133 134 178 207 69 23 78 24

15

Sources of Proceeds - $500 - $999 Million

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Bank Debt 46.56% 43.71% 34.95% 35.03% 45.45% 50.56% 50.74% 56.63% 42.70% 33.55% 44.16% 41.44%Secured Debt 0.00% 0.00% 0.00% 0.39% 0.00% 2.50% 1.06% 2.19% 0.81% 0.00% 0.06% 0.00%Sr Unsec'd Debt 0.00% 0.00% 0.00% 2.48% 3.74% 4.29% 2.07% 1.30% 0.00% 14.01% 4.24% 11.39%Public/144a High Yield 7.69% 5.43% 19.47% 17.97% 16.27% 8.63% 5.63% 4.37% 0.00% 0.00% 2.37% 3.40%Bridge Loan 3.85% 15.70% 6.73% 2.74% 0.00% 1.49% 0.61% 0.00% 0.00% 14.01% 0.00% 0.00%Mezzanine 4.37% 0.00% 0.00% 0.00% 1.37% 0.92% 3.32% 1.22% 10.34% 0.00% 3.11% 4.11%HoldCo Debt / Seller Note 5.15% 6.11% 4.17% 1.25% 1.27% 2.70% 1.09% 0.29% 0.00% 0.00% 0.50% 0.00%Preferred Equity 11.56% 0.00% 8.90% 6.34% 1.69% 0.79% 0.00% 0.29% 0.00% 0.00% 0.00% 0.00%Common Equity 14.02% 16.92% 21.62% 30.04% 24.08% 25.63% 32.27% 30.43% 39.73% 45.67% 40.56% 30.50%Rollover Equity 2.66% 8.96% 1.84% 3.12% 2.34% 1.09% 2.06% 1.37% 6.38% 0.00% 2.94% 1.06%Other 4.13% 3.17% 2.31% 0.64% 3.78% 1.41% 1.14% 1.91% 0.04% 5.48% 2.07% 8.10%

Total Senior Debt 46.56% 43.71% 34.95% 37.90% 49.19% 57.35% 53.86% 60.13% 43.51% 47.56% 48.46% 52.83%Total Sub Debt 15.91% 21.13% 26.20% 20.71% 17.64% 11.04% 9.57% 5.58% 10.34% 14.01% 5.48% 7.51%Total Equity 33.39% 31.99% 36.54% 40.75% 29.39% 30.21% 35.42% 32.37% 46.11% 45.67% 43.99% 31.56%Average Loan Size $406.5M $325.3M $383.5M $291.0M $337.0M $341.2M $343.8M $301.1M $288.8M $333.3M $335.9M $324.2MAverage Sources $719.0M $722.4M $788.0M $725.0M $695.2M $660.4M $736.6M $704.0M $627.7M $618.1M $757.4M $709.9MObservations 12 7 9 13 23 29 33 49 11 4 25 6

16

Sources of Proceeds - $250 - $499 Million

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Bank Debt 43.80% 38.95% 46.64% 39.96% 44.33% 48.63% 55.61% 57.31% 45.35% NA 37.90% 48.50%Secured Debt 1.01% 0.00% 0.00% 0.00% 1.81% 0.34% 0.03% 0.24% 0.17% NA 3.14% 0.00%Sr Unsec'd Debt 2.02% 0.00% 0.00% 0.00% 2.57% 5.84% 3.59% 3.25% 0.00% NA 2.21% 0.00%Public/144a High Yield 1.88% 6.19% 2.52% 9.91% 9.65% 6.05% 1.42% 2.46% 0.00% NA -0.26% 2.20%Bridge Loan 1.90% 2.92% 0.00% 0.00% 0.36% 0.00% 0.00% 0.00% 0.00% NA 0.26% 0.00%Mezzanine 9.25% 6.41% 4.21% 4.42% 5.62% 4.41% 4.41% 0.96% 7.47% NA 8.84% 3.04%HoldCo Debt / Seller Note 1.43% 2.57% 2.81% 1.97% 0.91% 0.00% 0.20% 0.00% 0.00% NA 0.96% 0.00%Preferred Equity 9.62% 2.77% 3.71% 4.26% 2.81% 0.01% 0.10% 0.00% 0.00% NA 3.43% 0.00%Common Equity 23.30% 31.26% 35.24% 29.58% 28.67% 31.06% 31.93% 33.01% 42.07% NA 41.07% 39.65%Rollover Equity 4.62% 7.11% 2.74% 9.26% 1.81% 3.12% 2.63% 2.57% 4.90% NA 1.74% 4.37%Other 1.16% 1.81% 2.13% 0.63% 1.47% 0.55% 0.06% 0.21% 0.04% NA 0.69% 2.24%

Total Senior Debt 46.83% 38.95% 46.64% 39.96% 48.71% 54.81% 59.24% 60.80% 45.52% NA 43.25% 48.50%Total Sub Debt 13.03% 15.52% 6.73% 14.33% 15.62% 10.46% 5.83% 3.42% 7.47% NA 8.84% 5.24%Total Equity 38.97% 43.71% 44.50% 45.07% 34.20% 34.19% 34.87% 35.58% 46.97% NA 47.21% 44.02%Average Loan Size $203.1M $143.8M $164.1M $156.9M $172.4M $187.2M $192.3M $188.7M $176.0M $161.5M $137.2M $177.8MAverage Sources $355.6M $389.4M $324.3M $336.5M $346.6M $374.9M $360.3M $382.1M $362.5M $376.4M $372.3M $398.4MObservations 25 14 14 16 41 43 45 46 21 8 19 10

17

Sources of Proceeds – Less than $250 Million

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 3Q11Bank Debt 49.05% 45.93% 43.83% 42.38% 48.69% 59.46% 55.77% 60.36% 35.94% NA 43.46% NASecured Debt 0.34% 0.00% 0.00% 0.00% 0.31% 0.19% 1.37% 0.00% 0.40% NA 0.00% NASr Unsec'd Debt 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% NA 0.19% NAPublic/144a High Yield 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.56% 0.00% 0.00% NA 0.01% NABridge Loan 0.00% 0.00% 0.00% 0.00% 0.56% 0.00% 0.00% 0.00% 0.00% NA 0.00% NAMezzanine 10.87% 7.21% 8.26% 12.86% 6.82% 7.23% 6.11% 5.11% 20.57% NA 10.95% NAHoldCo Debt / Seller Note 1.82% 7.22% 3.34% 1.84% 0.23% 0.00% 0.19% 0.00% 0.00% NA 0.00% NAPreferred Equity 7.60% 6.89% 11.88% 7.03% 3.38% 2.06% 0.86% 0.00% 0.00% NA 0.00% NACommon Equity 25.67% 25.07% 26.61% 29.92% 35.02% 28.20% 32.13% 30.18% 42.49% NA 42.92% NARollover Equity 3.60% 3.83% 2.29% 3.43% 3.00% 2.88% 2.87% 2.13% 0.61% NA 2.47% NAOther 1.07% 3.88% 3.79% 2.53% 2.00% 0.00% 0.13% 2.22% 0.00% NA 0.00% NA

Total Senior Debt 49.39% 45.93% 43.83% 42.38% 49.00% 59.65% 57.14% 60.36% 36.34% NA 43.65% NATotal Sub Debt 10.87% 7.21% 8.26% 12.86% 7.38% 7.23% 6.67% 5.11% 20.57% NA 10.96% NATotal Equity 38.69% 43.01% 44.12% 42.22% 41.63% 33.14% 36.06% 32.31% 43.10% NA 45.39% NAAverage Loan Size $100.2M $70.1M $106.8M $84.4M $96.2M $98.3M $108.1M $98.6M $85.9M $88.8M $79.8M $85.0MAverage Sources $159.8M $153.6M $179.1M $158.9M $188.7M $182.1M $181.2M $180.7M $184.1M $176.9M $183.4M $144.4MObservations 42 17 12 24 42 35 46 40 14 8 14 2

18

Sources of Proceeds – Middle Market

2004 2005 2006 2007 2008 2009 2010 2Q11Bank Debt 46.96% 55.55% 55.12% 58.08% 43.22% NA 39.84% 44.00%Secured Debt 0.45% 0.34% 0.89% 1.11% 0.29% NA 2.38% 0.00%Sr Unsec'd Debt 1.01% 1.70% 0.00% 0.75% 0.00% NA 0.09% 0.00%Public/144a High Yield 2.00% 0.00% 0.73% 1.71% 0.00% NA 0.00% 0.00%Bridge Loan 0.61% 0.00% 0.00% 0.00% 0.00% NA 0.00% 0.00%Mezzanine 7.42% 6.70% 6.21% 2.85% 11.11% NA 9.31% 4.18%HoldCo Debt / Seller Note 0.76% 0.00% 0.24% 0.00% 0.00% NA 0.76% 1.07%Preferred Equity 3.12% 0.79% 0.55% 0.00% 0.00% NA 1.86% 0.00%Common Equity 32.90% 31.57% 33.27% 32.14% 40.22% NA 42.18% 47.59%Rollover Equity 2.94% 3.04% 2.86% 2.09% 5.12% NA 2.30% 3.17%Other 1.84% 0.31% 0.12% 1.27% 0.04% NA 1.29% 0.00%

Total Senior Debt 48.42% 57.59% 56.01% 59.94% 43.51% NA 42.31% 44.00%Total Sub Debt 10.03% 6.70% 6.94% 4.56% 11.11% NA 9.32% 4.18%Total Equity 39.72% 35.40% 36.92% 34.23% 45.34% NA 47.10% 51.83%Average Loan Size $118.1M $126.0M $109.2M $97.2M $96.9M $92.3M $103.6M $146.0MAverage Sources $239.6M $260.9M $241.3M $255.6M $269.4M $202.5M $287.3M $261.0MObservations 61 60 74 61 23 11 27 6

19

Sources of Proceeds – Middle Market

2004 2005 2006 2007 2008 2009 2010 3Q11Bank Debt 46.96% 55.55% 55.12% 58.08% 43.22% NA 39.84% 44.34%Secured Debt 0.45% 0.34% 0.89% 1.11% 0.29% NA 2.38% 0.00%Sr Unsec'd Debt 1.01% 1.70% 0.00% 0.75% 0.00% NA 0.09% 0.00%Public/144a High Yield 2.00% 0.00% 0.73% 1.71% 0.00% NA 0.00% 3.19%Bridge Loan 0.61% 0.00% 0.00% 0.00% 0.00% NA 0.00% 0.00%Mezzanine 7.42% 6.70% 6.21% 2.85% 11.11% NA 9.31% 2.37%HoldCo Debt / Seller Note 0.76% 0.00% 0.24% 0.00% 0.00% NA 0.76% 1.18%Preferred Equity 3.12% 0.79% 0.55% 0.00% 0.00% NA 1.86% 0.00%Common Equity 32.90% 31.57% 33.27% 32.14% 40.22% NA 42.18% 40.81%Rollover Equity 2.94% 3.04% 2.86% 2.09% 5.12% NA 2.30% 6.35%Other 1.84% 0.31% 0.12% 1.27% 0.04% NA 1.29% 1.77%

Total Senior Debt 48.42% 57.59% 56.01% 59.94% 43.51% NA 42.31% 44.34%Total Sub Debt 10.03% 6.70% 6.94% 4.56% 11.11% NA 9.32% 5.56%Total Equity 39.72% 35.40% 36.92% 34.23% 45.34% NA 47.10% 48.34%Average Loan Size $118.1M $126.0M $109.2M $97.2M $96.9M $92.3M $103.6M $139.6MAverage Sources $239.6M $260.9M $241.3M $255.6M $269.4M $202.5M $287.3M $313.7MObservations 61 60 74 61 23 11 27 7

20

New-Issue LBO Loan Volume by Industry

Institutional ($9.4B)

0% 10% 20% 30% 40% 50%

Metals & Mining

Building Materials

Telecom

Industrial

Healthcare

Computers &Electronics

Services/ Retail

Total ($11.9B)

0% 10% 20% 30% 40% 50%

Metals & Mining

Building Materials

Telecom

Industrial

Healthcare


Services/ Retail

21

Middle Market Activity

(Defined as Issuers with EBITDA of $50 Million or Less)

22

Middle Market LBO Loan Volume – by Year

23

To access the data points underlying the chart, double-click on the chart.

Middle Market LBO Loan Volume – by Quarter

$0

$2

$4

$6

$8

1Q97

3Q97

1Q98

3Q98

1Q99

3Q99

1Q00

3Q00

1Q01

3Q01

1Q02

3Q02

1Q03

3Q03

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

In B

illio

ns

Institutional Pro Rata

24

Institutional New-Issue Volume ($1.18B)

38.0%

20.0%

16.0%

15.0%

11.0%

0% 10% 20% 30% 40% 50%

Services & Leasing


Restaurants

Building Materials

Chemicals

New-Issue Middle Market LBO Loan Volume by Industry

Total New-Issue Volume ($1.34B)

39.0%

19.0%

16.0%

15.0%

11.0%

0% 10% 20% 30% 40% 50%

Services & Leasing


Restaurants

Building Materials

Chemicals

25

To access the data points underlying the chart, double-click on the chart. For on-line news & commentary: www.lcdcomps.com


26.0%

17.0%

10.0%

10.0%

10.0%

9.0%

4.0%

4.0%

4.0%

4.0%

2.0%

0% 5% 10% 15% 20% 25% 30%

Services & Leasing

Computers & Electronics

Building Materials

Manufacturing & Machinery

Restaurants

Healthcare

Aerospace & Defense

Telecom

Chemicals

Retail

Not for Profit

New-Issue Middle Market LBO Loan Volume by Industry


25.0%

14.0%

10.0%

9.0%

9.0%

8.0%

7.0%

6.0%

4.0%

4.0%

2.0%

1.0%

0% 5% 10% 15% 20% 25% 30%

Services & Leasing

Computers & Electronics

Building Materials

Manufacturing & Machinery

Restaurants

Healthcare

Chemicals

Telecom

Aerospace & Defense

Retail

Not for Profit

Textile & Apparel

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Middle Market Sponsored Loan Volume – by Year

14.8

23.7 24.2

20.6

5.0

7.66.7

20.9

25.1

22.520.9

5.0

2.2

8.8

6.4

11.2

$0B

$10B

$20B

$30B

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

1Q-3

Q10

1Q-3

Q11


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To access the data points underlying the chart, double-click on the chart.

Middle Market Sponsored Loan Volume – by Quarter

$0

$5

$10

$15

1Q97

3Q97

1Q98

3Q98

1Q99

3Q99

1Q00

3Q00

1Q01

3Q01

1Q02

3Q02

1Q03

3Q03

1Q04

3Q04

1Q05

3Q05

1Q06

3Q06

1Q07

3Q07

1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

In B

illio

ns


28


16.0%14.0%

10.0%10.0%

9.0%4.0%4.0%4.0%

3.0%3.0%3.0%3.0%3.0%

2.0%2.0%2.0%2.0%2.0%

1.0%1.0%1.0%1.0%1.0%

0% 5% 10% 15% 20%

Services & LeasingHealthcare

Manufacturing & MachineryComputers & Electronics

RestaurantsChemicals

Building MaterialsPrinting & Publishing

RetailTelecom

Not for ProfitForest Product

Textile & ApparelAerospace & Defense

Food & BeverageRetail Food & Drug

InsuranceEnvironmental

Entertainment & LeisureCable

AutomotiveOil & Gas

Home Furnishings

Middle-Market Sponsored Volume by Broad Industry


16.0%13.0%

10.0%9.0%9.0%

6.0%5.0%

4.0%4.0%

3.0%3.0%3.0%3.0%

2.0%2.0%2.0%2.0%

1.0%1.0%1.0%1.0%1.0%1.0%

0% 5% 10% 15% 20%

Services & LeasingHealthcare

Manufacturing & MachineryRestaurants

Computers & ElectronicsTelecom

ChemicalsRetail

Building MaterialsTextile & Apparel

Printing & PublishingNot for Profit

Food & BeverageForest Product

Aerospace & DefenseRetail Food & Drug

InsuranceEnvironmental

Entertainment & LeisureAutomotive

CableOil & Gas

Home Furnishings

29

© 2012 Venable LLP

I. Type of instrument. A. Unsecured Debt – most common B. Preferred Stock – least common

II. Maturity – typically 5 years but varies widely

Typical Mezzanine Terms

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© 2012 Venable LLP

I. Mezzanine debt instruments A. Cash coupon

i. Fixed rate - payable semi-annually or quarterly

ii. Floating rate B. Option to pay interest in-kind (by issuing

additional mezzanine debt) C. Seek to achieve higher internal rate of return

(IRR) by a combination of the interest rate, fees and the equity component.

Interest rates and fees.

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© 2012 Venable LLP

II. Mezzanine preferred equity investments A. Typically structured—high fixed-rate dividend —

paid in cash or in-kind—may feature an optional or mandatory conversion into common equity.

ii. May negotiate for different types of one-time or periodic payments, including structuring, commitment or other fees and they may request that mezzanine debt is issued at a discount to par (original issue discount ) (OID), which has the effect of increasing the instrument's yield.

iii. Not uncommon to be reimbursed for their legal and other out-of-pocket fees.

Interest rates and fees.

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© 2012 Venable LLP

I. Holding Company

A. How to ensure repayment B. Pledge Issues C. Controlling Distributions D. Bankruptcy Issues E. Borrower/Guarantor issues

II. Operating Company A. Cleaner path to ownership in meltdown

scenario B. Reps/Warranties/Covenants likely to be

more straight forward C. Generally the way senior debt is

structured.

Issuers

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Ranking in the Capital Structure.

I. Mezzanine Debt Holders A. Typically—contractually subordinated to existing

and certain future holders of senior debt of the issuer.

B. Less commonly—structural subordination i. Preferred equity instrument—junior to all

debt in the capital structure. II. Security – Typically unsecured

© 2012 Venable LLP

34

© 2012 Venable LLP

I. Usually based on: A. high-yield style covenants

a) incurrence-based only b) may include financial maintenance

B. or bank facility covenant packages a) Some maintenance covenants.

II. Existing senior bank facility, or is entering into a new bank facility in connection with mezz deal A. Covenant package may be largely based on the

covenants in the credit facility. B. “baskets” and financial maintenance covenants

are typically at least 10% to 30% more permissive than the corresponding provisions in the senior credit facility.

Covenants

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© 2012 Venable LLP

iii. Senior lenders often join the issuer in pushing for this additional flexibility to ensure that a default under the senior credit facility does not immediately result in default on the mezzanine side requiring the senior lenders to invoke (and rely on) their contractual standstill rights.

III. Key negative Covenants

A. Incurrence of debt B. Restricted Payments C. Liens D. Change of control transactions E. Asset sales F. Affiliate transactions

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© 2012 Venable LLP

IV. Affirmative covenants may include: A. Financial reporting. B. Maintenance of insurance. C. ERISA compliance. D. Recent mezzanine transactions, especially

those providing financing for acquisitions by financial sponsors, often look fairly similar to incurrence-based covenant packages in marketed high-yield debt instruments. i. Primary difference is that some

mezzanine investors seek to tighten certain covenants and baskets as compared to marketed high-yield covenants, and to receive certain additional information rights.

V. “Jumbo” mezzanine financings - intended to be syndicated - may also include provisions designed to enhance transferability of the debt.

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© 2012 Venable LLP

I. Vary widely in mezzanine financings based on changing market expectations and the specific purpose of each financing.

A. Call protection (prepayment limitations and penalties) –

i. more commonly found in high-yield debt ii. Bank debt, there is generally no

prepayment penalty for mandatory prepayments

B. Mandatory prepayment/redemption provisions following certain events

Redemption and Call Protection

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© 2012 Venable LLP

II. Most Common A. Change of control transactions (with

redemption prices ranging from 101% of par to the applicable optional redemption price on that date)

B. Asset sales (at par), C. Some mezzanine instruments - significant

acquisitions and other major corporate transactions.

III. Mezzanine debt that is similar bank debt A. Mandatory prepayments tied to debt or cash

sweeps B. Optional prepayments at par or at low or

declining premiums (for example, notes may be redeemed at 103% of their principal amount in the first year after issuance, 102% in the second year and 101% in the third year).

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© 2012 Venable LLP

IV. High-yield debt - similar to marketed high-yield notes A. no-call periods, with exceptions for "make-whole"

redemption provisions B. provisions allowing the issuers to redeem a

specified percentage of the outstanding debt using the proceeds from certain equity offerings

C. Provisions tend to be more varied than marketed high-yield bond issues—may include i. a longer no-call period, ii. higher redemption premiums iii. additional redemption triggers, such as the

sale of specified key assets

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© 2012 Venable LLP

I. Regularly included A. Warrants or options to purchase a specified

percentage of equity (often 1% to 5%) in the issuer— typically "penny" instruments that can be exercised or transferred, subject to compliance with SEC Rules

B. Right to co-invest in the issuer alongside the controlling stockholder or a private equity sponsor— typically at the same price

C. Conversion feature—allowing conversation of principal investment into common equity of the issuer.

D. Mezzanine investors are generally not looking to be long-term stockholders—transactions are structured with fixed rates of return (that is, higher interest rates) without equity kickers.

Equity Participation (kicker)

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© 2012 Venable LLP

I. Historically : buy and hold products rarely traded A. Some recent transactions ("jumbo" transactions

and large funds) —seek to increase liquidity by requiring issuers

i. Qualify the notes for settlement through the book-entry facilities of DTC

ii. maintain eligibility for resales of the notes under Rule 144A

B. Some Practical Limitations on Transferability i. issuer's interest in prohibiting transfers

to competitors, ii. lack of available information iii. Desire to permit sales of mezzanine

debt and corresponding equity only as a unit

Transferability

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© 2012 Venable LLP

I. Principal instrument – i. Indenture ii. Credit agreement (mezzanine debt) iii. certificate of designations (preferred stock).

II. Securities purchase agreement—if debt is notes i. Including reps and warranties and closing

conditions. ii. May also contain the covenant package (in

which case, a separate indenture with a third-party indenture trustee is not required).

III. Separate intercreditor agreement—with senior creditors.

Primary Documentation

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© 2012 Venable LLP

IV. Co-investment, option or warrant agreement—equity participation by mezzanine investors is documented

V. Stockholders, registration rights and other similar agreements with the issuer's other equity holders

A. Typically no offering memo or disclosure documents or comfort letter or assurance letters—mezzanine investments tend to involve a small number of highly sophisticated institutional investors who conduct an extensive due diligence review of the issuer.

B. Usually receive customary corporate legal opinions (such as due incorporation, due authorization, enforceability of key documents, etc.) and closing certificates.

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© 2012 Venable LLP

I. Intercreditor Relationships - Type and amount of debt to which mezzanine investors will agree to be subordinated is frequently a highly negotiated point

A. Subordination provisions in the debt instruments, together with the intercreditor agreement, commonly provide that payments on the mezzanine notes will be suspended if a payment default occurs on the designated senior debt.

B. Blockage notice—If Covenant default under the designated senior debt occurs—suspends payment on the mezzanine debt for up to 179 days.

Key Issues

45

© 2012 Venable LLP

i. Mezzanine investors generally limit the senior lenders to one blockage notice per 365-day period

ii. Sometimes limit the total number of blockage notices that can be delivered during the term of the mezzanine.

C. Standstill provisions - Some senior lenders negotiate for complete subordination - most cases, mezzanine investors resist these requests.

D. Turnover provisions i. X Clause—exception to the turnover

provision—permits payments in the form of permitted junior securities, —in limited circumstances before senior creditors are paid in full.

E. Bankruptcy—Some require the mezzanine investors to vote for any plan of reorganization supported by senior lenders.

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© 2012 Venable LLP

I. Varies Widely A. Most deals require the issuer to provide annual

audited and quarterly unaudited financial statements.

B. Deals where the parties want the debt securities to be eligible for resale under Rule 144A

i. Covenant to provide holders and potential investors with all financial and corporate information required by Rule 144A

C. Many deals require issuers provide SEC-style reports similar in scope to what they would have to file with the SEC had they been public companies subject to periodic reporting requirements

D. Some have required issuers to deliver reports to investors upon the occurrence of each event that would trigger a Form 8-K.

Reporting and Information Rights

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© 2012 Venable LLP

i. Including "Management's Discussion and Analysis," "Business" and "Risk Factors" sections

ii. Usually exempt the issuer a) Providing information that is not material for the mezzanine investors, b) Having the chief executive officer and chief financial officer certify each quarterly or annual report or certify the issuer's internal controls.

II. Board Observer - Commonly negotiate for the rights to receive all board materials and to appoint a board observer (or in some cases, a director) if they hold a specified percentage of their initial investment, which can be as low as 10% or as high as 50%.

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© 2012 Venable LLP

I. A Viable Exit Strategy - critical to the decision to participate in a mezzanine funding.

i. The sale of the issuer. ii. A recapitalization. iii. A refinancing. iv. An initial public offering

II. Limited equity interests - ordinarily they have limited leverage to negotiate for more than standard tag-along rights and registration rights, as well as customary anti-dilution protections.

III. Larger equity stakes - may also negotiate for veto rights for specified corporate actions including equity offerings, mergers, affiliate transactions or changes in senior management.

Equity Component

50

© 2012 Venable LLP

Senior lender is protected by its security in the property.

Surprise bankruptcy filing by senior lender could eliminate the SPE’s equity. – Mezz lenders sought protection by requiring the

consent of an independent director to file.

Bankruptcy Concerns for Mezz Lenders

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© 2012 Venable LLP

In re General Growth Properties, Inc., 409 B.R. 43, 51 (Bankr. S.D. N.Y. 2009).

Delaware law - Most LLCs used in debt stacks are formed in DE.

Court held that independent director could be replaced, could permit a bankruptcy filing and could enable the debtor to access the use of the SPE's assets.

GGP Bankruptcy

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© 2012 Venable LLP

Requiring notice to the servicers and the lenders prior to replacement of the independent directors/managers

Requiring the servicers' and lenders' prior written consent to replace an independent director/manager and to identify each replacement

Mezz Lender Solutions to the GGP Scenario

53

© 2012 Venable LLP

SPE's operating agreement should provide: – bankruptcy filing cannot occur without the approval

all the directors/managers – the directors/managers owe duties to protect

creditors in the enforcement of their contractual rights.

Non-Recourse Carveout Guarantees

Solutions to the GGP Scenario

54

© 2012 Venable LLP

One or More Principals of the borrower guarantee against loss from many actions including: – violations of the SPE covenants and

representations – violations of transfer or subordinate mortgage or

other debt restrictions, – filing of any bankruptcy petition

Created a unintended situation where the borrower was unable to use bankruptcy to work out issues with the senior lenders.

Nonrecourse Carveout Guaranty

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© 2012 Venable LLP

Bank of America, N.A. v. PSW NYC LLC, 918 N.Y.S.2d 396 (Sup 2010).

Mezz lender sought to foreclose on equity and then cause the entity to file a Chap. 11 – Automatic stay to stop the senior lender – Use Chap. 11 provisions to cram down the senior

debt

Stuyvesant Town/ Peter Cooper Village

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© 2012 Venable LLP

Senior Lender sought an injunction based on an intercreditor agreement that prohibited Mezz foreclosure until after the senior debt had been satisfied.

Mezz lender argued that the provision would merely acclerate the debt after the Mezz foreclosure.

Court granted the Senior lenders request for injunciton.

Stuyvesant Town/ Peter Cooper Village

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© 2012 Venable LLP

Intercreditor Agreement must be scrutinized/negotiated to ensure the each party understands its rights.

Mezz Lender must insist on language giving right the mezzanine lender has is the ability to receive notice of, and an opportunity to cure, any defaults in the senior debt, which includes the right to purchase the senior debt in the event of a default. – This prevents a Loan to Own situation where the

senior lender wipes out all the Mezz debt by forcing the SPE into Bankrupcy

Lessons from Peter Cooper Village

mezzanine financing: legal considerations for...

Documents