Bridging the Gap: How Investors Extend the Life of Their Funds
September 20, 2023
This article was first published by Middle Market Growth.
At a time of decreased deal flow and mismatched valuation expectations, investors are using creative tools to provide capital to companies or extend the life of their funds
With various stressors weighing on the investment industry, deal flow for traditional platform buyouts has declined and valuation expectations have also fallen.
Rising interest rates and inflation, the collapse of several regional banks, and declining equity values have all changed the game for M&A practitioners. Some are waiting on the sidelines while market conditions improve, while others are employing specialty investment strategies to bridge the pricing gap or agree to terms when there is a valuation mismatch.
Some of these tools—like preferred equity or mezzanine funding—are used to help companies in need of capital for growth or add-on acquisitions while traditional debt or equity financing is unavailable. Other strategies like earnouts, seller notes and ratchets get tapped to close a deal when there is disagreement on valuation or performance metrics between the buyer and seller. Net asset value (NAV) lending and continuation funds, meanwhile, are becoming popular ways for private equity funds and portfolio companies to extend their runway before an exit.
These instruments are often costly and create complex capital structures or throw the priority in which lenders and investors get repaid out of order. But investors say they’re still useful options at a time when access to traditional equity and debt capital is challenging. We explore some of these strategies in detail below.
Investors sometimes use mezzanine financing, a type of junior debt, as an alternative to equity or debt financing. Mezz acts as a high-yield loan that typically is less dilutive or expensive than equity but costlier than other types of debt. The loan is usually secured by a second lien on the assets of the company. Although it’s priced like junior debt, it sits between equity and senior debt in the capital stack.
If you believe in the equity story and the company is growing, mezz can be a compelling growth lever for your business.