580 20 Acquisition Finance
The issuing of shares may take the form of an IPO, a private placement, or a joint
venture.
20.7 Mezzanine
Mezzanine capital can close the gap between traditional shareholders’ capital and
debt financing. As explained in Chapter 6, mezzanine financing can consist of
debt mezzanine or equity mezzanine instruments. In other words, the “equity
technique” means that debt instruments are made to behave more like shares and
shares more like debt instruments (section 5.1). Mezzanine financing can com-
plement traditional sources of financing where the acquirer’s capital requirements
are substantial or the acquirer needs flexibility when structuring its financing mix.
Mezzanine capital is popular even in the expansion phase of the firm.
Mezzanine loans. The buy-out transaction may only justify a limited amount of
senior debt on typical senior debt margins, fees, and gearing. If further debt is re-
quired to fund the acquisition, mezzanine debt may be available at a higher
price.^115 In large transactions, mezzanine debt can form an important part of the
funding package.
For lenders, mezzanine loans are a source of additional arranging and other
fees. They are also a source of higher margins.^116 In addition, mezzanine loans can
bring other benefits. There is typically a component that enables mezzanine lend-
ers to benefit from the increase of the value of the target’s shares. The firm should
take the cost of those benefits into account and should also investigate whether the
benefits can reduce the margin.
The margins are higher because of the use of subordination techniques. Typi-
cally, mezzanine loans are subordinated in the event of insolvency (but not to the
extent that their ranking falls as low as that of the claims of shareholders).^117 In
addition, mezzanine loans will have a longer maturity compared with senior loans
and may have a 5 to 10 year term. There is generally a one-time payment at the
expiry of the loan term (bullet repayment) often combined with early prepayment
premiums. Like mezzanine debt itself, collateral will typically be subordinated.
Mezzanine loans can benefit from security from the target company or security
and guarantees from target group companies, ranking behind the senior loans.^118
Where investors expect the value of the acquirer to increase, investors may pre-
fer to get their share of it. This can be achieved through an “equity kicker”. The
equity kicker can be real or synthetic.
(^115) Gayle C, Acquisition Finance – Syndication Best Practice, Int Comp Comm L R 13(8)
(2002) p 300.
(^116) Ibid, p 301.
(^117) For example, in Switzerland, contracts are drafted so as to avoid subordination as de-
fined in Art. 725(2) OR (Obligationenrecht, the Code of Obligations). See Barthold BM,
Mezzanine-Finanzierung von Unternehmensübernahmen, SZW/RSDA 5/2000 p 232.
(^118) Gayle C, op cit, p 301; Diem A, op cit, § 38 number 20.