BDCRI Business Building Seminar

1
BDCRI Business Building Seminar

• Putting Mezzanine Financing to Work
• September 28, 2006
• Warwick, Rhode Island

2
When Mezzanine Financing Makes Sense

• Presented by
• Jerry Cerce
• Partner, Management Capital
• jerry_at_mgtcapital.com

3
The Entrepreneurs Perspective

• Growing business
• Use all the bank debt you can
• Clean up the balance sheet
• Use of subordinated debt
• Middle step before going public

4
Private Equity with Mezzanine Financing

• Deal structures
• Sub-debt 2/3
• Equity 1/3
• Subordinated debt with equity enhances returns
• Most small and medium size companies fail due to
  balance sheet problems

5
When Mezzanine Financing Works

• Bridge between senior debt and equity
• Most important predictable cash flow

6
Mezzanine Financing at Work
7
Mezzanine Financing Pricing

• Presented by
• Peter Dorsey
• Sr. Vice President, Business Development Company
  of Rhode Island
• pdorsey_at_bdcri.com

8
Cost of Capital
9
Financing A Three-legged Stool
10
Net Present Value Calculation of IRR
Amount Borrowed 750,000
Application Fee 10,000
11
Case Studies in Mezzanine Financing

• Presented by
• Frank Epps
• CEO, Narragansett Imaging, LLC
• frank.epps_at_nimaging.com

12
When and Why We Used Mezzanine

• Finance growth
• When A project that required significant upfront
  investment that generated future cash flow.
• Why Maximized senior lenders appetite for risk
• Leveraged buy out
• When
• Finance asset purchase of established corporation
• Why
• Retained majority sr. facility for working
  capital
• Preserved owners equity

13
Hybrid Debt Trade Offs and Justifications
Trade Offs
Justifications

• Higher return expected
• Expensive debt
• 20 ROI from combo of
• coupon equity instrument
• Personal guarantees
• Sometimes required
• Warrants or shares
• Included in deal or
• used as a penalty

• Negotiable terms
• Cash flow benefits
• Subordination
• Equity in banks eyes
• Considered unsecured
• Available for senior
• Less costly than equity
• Maximize return

14
Covenant Calculation with Mezzanine Debt
Maximum Leverage Ratio Total Liabilities to
Tangible Net Worth Balance Sheet Liabilities
Less Subordinated Debt Warrant Balance Sheet
Net Worth Plus Subordinated Debt Less
Intangible Assets
15
No Matter What You Call ItDebt Is Debt

• You need to demonstrate
• The cash flow ability to service the debt
• A track record within the industry
• A history of profitability
• A solid management team
• A viable expansion or growth plan
• The right lender will become your partner
• Match cultures, objectives, sectors,
  personalities
• Theyre taking a risk allow the reward
• Flexibility when you need it
• Maintain open communications

16
Example - Capital Structure Mix - LBO

• Target Company Purchase for 5X EBITDA
• Senior Facility 2x 2.5x EBITDA
• Mezzanine 1x 1.5x EBITDA
• Equity Required 2x 1x EBITDA
• Assumptions
• Realistic multiple sector, stage, etc.,
• Sufficient net working capital
• Demonstrate cash flow for operations, debt
  service
• Realistic growth demonstrated experience