Chapter 24 CAIA Flashcards - Debt Types of Private Equity
WACC
The weighted average cost of capital for a firm is the sum of the products of the percentages of each type of capital used to finance a firm times its annual cost to the firm.
Mezzanine Financing
Generally, mezzanine financing occurs in amounts below $400 million.
A PIK Toggle
A PIK toggle allows the underlying company to choose whether it will make required coupon payments in the form of cash or in kind, meaning with more mezzanine bonds. Leveraged loans do not have such a provision.
Seven Basic Transactions of Mezzanine Financing
MEZZANINE FINANCING FOR A MANAGEMENT BUYOUT (MBO)
MEZZANINE FINANCING FOR GROWTH AND EXPANSION
MEZZANINE FINANCING FOR AN ACQUISITION
MEZZANINE FINANCING TO RECAPITALIZE A COMPANY:
MEZZANINE FINANCING IN COMMERCIAL REAL ESTATE:
MEZZANINE FINANCING IN A LEVERAGED BUYOUT:
MEZZANINE FINANCING AS BRIDGE FINANCING
MEZZANINE FINANCING FOR A MANAGEMENT BUYOUT (MBO):
MEZZANINE FINANCING FOR A MANAGEMENT BUYOUT (MBO): When the senior management team of a firm leads an MBO, mezzanine debt can fill the gap between senior debt claims and equity.
MEZZANINE FINANCING FOR GROWTH AND EXPANSION:
MEZZANINE FINANCING FOR GROWTH AND EXPANSION: A company pursuing growth that cannot raise traditional bank financing or public financing may seek mezzanine financing.
MEZZANINE FINANCING FOR AN ACQUISITION:
MEZZANINE FINANCING FOR AN ACQUISITION: A middle-market company seeking to purchase an even smaller company may seek mezzanine debt financing as part of the capital for the acquisition.
MEZZANINE FINANCING TO RECAPITALIZE A COMPANY:
MEZZANINE FINANCING TO RECAPITALIZE A COMPANY: Mezzanine debt may be used as part of a new capital structure for a firm to create a new balance sheet, such as having a senior term loan, senior subordinated mezzanine debt, junior subordinated mezzanine debt, convertible preferred stock, and common equity.
MEZZANINE FINANCING IN COMMERCIAL REAL ESTATE:
MEZZANINE FINANCING IN COMMERCIAL REAL ESTATE: Mezzanine capital fills the gap between first-mortgage financing, which usually has a loan-to-value ratio of 40% to 75%, and the equity contributed to the project. Typical equity contributions for real estate are in the 10% to 15% range. It is in between bank loans and equity that mezzanine financing exists, historically supplying 10% to 40% of a project’s capital structure.
MEZZANINE FINANCING IN A LEVERAGED BUYOUT:
MEZZANINE FINANCING IN A LEVERAGED BUYOUT: Mezzanine financing is an established component of many leveraged buyouts. An LBO requires a large amount of debt, and not all debt can be senior. A significant amount of the financing may come from mezzanine investors.
MEZZANINE FINANCING AS BRIDGE FINANCING:
MEZZANINE FINANCING AS BRIDGE FINANCING: Often, a good portion of the initial debt in an LBO is raised as bridge financing. Bridge financing is a form of gap financing—a method of debt financing that is used to maintain liquidity while waiting for an anticipated and reasonably expected inflow of cash.
Intercreditor Agreement
An intercreditor agreement is an agreement with the company’s existing creditors that places restrictions on both the senior creditor and the mezzanine investor.
Blanket Subordination
A blanket subordination prevents any payment of principal or interest to the mezzanine investor until after the senior debt has been fully repaid.
Springing Subordination
A springing subordination allows the mezzanine investor to receive interest payments while the senior debt is still outstanding.
Distressed Debt
Distressed debt is often defined as debt that has deteriorated in quality since issued and that has a market price less than half its principal value, yields 1,000 or more basis points over the riskless rate, or has a credit rating of CCC (Caa) or lower.
