As Banks Back Off, Firms Say Equity-Debt Deals Growing
If public offerings and venture capital are the sexy sides of business financing, then mezzanine funding is the nuts and bolts, the block and tackle, the vanilla ice cream.
Mezzanine funds, a combination of debt and equity, typically receive a 20% to 30% return,more than commercial bank loans, but far less than the best venture capital investments.
In Orange County, though, mezzanine financing plays a key role, especially in company buyouts or expansions.
Mezzanine funding allows investors to take a small share of a company as well as collect interest on a loan. Companies typically need mezzanine funding when they can’t hold any more bank debt and equity capital is too hard to come by.
“The mezzanine market is active right now, because secured lenders have cut back,” said Jeff Jacobsen, vice president and division manager of Wells Fargo Mezzanine Capital, a division of Wells Fargo & Co. “They are not putting out as much money. Most of the gap is taken up by the mezzanine lenders,”
Much like the venture capital industry, the number of firms offering mezzanine financing in Orange County are few and far between.
“There are more (players) here than five years ago, but it is still an underserved market,” said Chris Britt, president of Newport Beach-based Marwit Capital LLC, a mezzanine firm.
From its small, second story office at the south end of Newport Center, Marwit has been doling out mezzanine capital in OC for more than two decades. It is in the process of opening an office in Los Angeles and is working on forming a new fund.
Marwit has invested in a variety of companies, such as a movie theater operator, a giftware manufacturer, a mobile home park operator, a medical billing company, a food distributor, a ticketing software provider and several manufacturing companies.
In the past five years, the firm has made 28 investments, 25 of which were in California companies, Britt said. Its internal rate of return on the investments is 27%, he said.
Marwit operates at the smaller end of mezzanine financing, along with its Newport Beach neighbor, Pinecreek Capital Management LLC, doing deals in the $1 million to $5 million range. In August, Marwit led a $10 million round for ticketing software company Paciolan, which recently moved to Irvine from Long Beach.
There are only a few other players scattered around the region that handle mezzanine investments. And Marwit and Pinecreek are overshadowed by firms such as The Audax Group, a Boston-based investment firm that recently opened an office at the north end of Newport Center.
While the smaller firms typically make investments of less than $10 million, the Audax Group is looking to handle larger deals. It is in the middle of closing a $500 million mezzanine fund and adding to its $500 million private equity and buyout fund and a $75 million venture capital fund.
Another Newport Beach mezzanine firm, Windjammer Capital Investors recently closed a $370 million mezzanine fund.
“Every time I turn around there is more and more mezzanine lending,” Wells Fargo’s Jacobsen said. “There are opportunities for mezzanine firms that want to work with smaller companies. This is a pendulum that swings, in a year or two it will be different.”
While the demand for mezzanine funding is growing, it comes with its share of risk. The downturn in the economy, coupled with a few loans that were too risky, put Scottsdale, Ariz.-based The Finova Group Inc., a billion-dollar investment firm, into bankruptcy. Finova is now entertaining penny-on-the-dollar buyout offers from Berkshire Hathaway Inc. and GE Capital.
As pure equity investments have slowed and banks have tightened their lending, many companies are turning to mezzanine financing to fill the gap.
“Last October, the banks contracted their lending parameters,” said Randy Zurbach, a Pinecreek principal. “It has opened up the market for the subordinated debt players.”
Much of the growth for mezzanine firms comes as commercial banks tighten the reins on lending.
“Banks are our principal competition,” Britt said. “But they are not now, because they aren’t doing a lot of cash-flow lending. It is a very cyclical market. All of a sudden the opportunity spectrum opened up again.”
The mezzanine firms have a close relationship with banks. If a bank can only loan part of what a company needs, a mezzanine firm usually can bridge the gap. And it works the other way, too.
“We often bring in a bank to finish a deal,” Britt said. “Subordinated debt is the grease that oils the capital markets. A company can only get so much financing from a bank,where do yo
