Research

EMPEA’s Professional Development Webcast, Mezzanine Financing in Emerging Markets took place on Thursday, November 13th and drew more than 180 registrants from 30 countries. Due to the robust audience participation and Q&A during the live event, the panel was unable to address all delegates’ questions during the one-hour timeframe. In an effort to continue the dialogue from the event, the panelists kindly took time to answer a handful of outstanding questions following the webcast. The questions and anonymized responses may be found below.

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Are there times when mezzanine becomes unattractive for companies / owners (i.e., when does it not work)?

• When there is plenty of liquidity in the banking market and mid-sized companies can have access to long-term bank loans at low interest rates.

• Early stage businesses without a track-record of generating cash flows require venture capital or development capital equity funding rather than mezzanine.

• There are several situations where mezzanine may not be the appropriate solution: 

  1. Early stage companies with no or limited operating cash flow.
  2. Availability of cheap equity (i.e., unreasonably high valuations).
  3. Companies with low return on equity.

Are there any reasons why the management fee should be different from the management fee paid in the context of a traditional PE fund?  What are the type of structures that have worked best for SMEs (i.e., for deals between US$2 million and US$10 million)?

• We believe there should be no difference in management fees between mezzanine and PE funds. We follow the standard 2/20 model in our fund.  Our minimum mezzanine deal size is US$10 million with a typical loan with warrants structure.

• Both the upfront work and the ongoing monitoring workload is not materially different from a PE fund and this justifies adopting the PE remuneration model. For instance, our due diligence processes are always on par with PE and in some cases more extensive than PE. In addition to the financial, legal, technical, commercial and ESG due diligence investigations, we often need to get fixed assets valued for security purposes, and need to spend time carefully assessing the quality of the receivables and inventory; activities which are not necessarily required by PE due diligence processes. We are generally as involved at board level as PE sponsors. We almost always take observer seats on the board and audit committees, and occasionally on the remuneration committees as well.

• The fees should not be substantially different than PE. A slightly lower management fee (1.50% – 1.75%) is justified given the difference in execution and portfolio management, however there is no reason for lower carry.

In which sectors has mezzanine worked best?

• The focus should be on the cash flow profile of the company instead of the sectors. Mezzanine works best with companies that have stable operating cash flow. Thus, most business sectors would work reasonably well with mezzanine, except perhaps for the IT sector.

• Mezzanine is less about sectors than the strength and sustainability of operating cash flow. Many sectors work as long as you find the right company with a solid business model and defensible market position.

• We have found infrastructure (power, telecom, cement), real-estate and pharma to be the most interesting sectors for us in our second fund.

Thoughts about developed market mezzanine investors going to Africa?

• I am a skeptic about developed market mezzanine investors entering the African market for a number of reasons: (i) we have found local, on-the-ground contacts to be key to good deal flow generation and it will be very difficult for a developed market player to source a mezzanine team composed of people from half a dozen different African countries with a substantial network of contacts in multiple markets and relevant transactional experience; and, (ii) African mezzanine is a product that is difficult to export; most LPs that are interested in Africa are not interested in credit or mezzanine so the only way to raise a substantial fund is to have deep and established relationships with African LPs that a developed market mezzanine investor will not have.

For additional questions about the Mezzanine in Emerging Markets report or to learn more about EMPEA’s Consulting Services, please contact the team at any time via email at consulting@EMPEA.net or via phone at +1 202 333 8171.