The Mezzanine Level
Mezzanine Financing provides borrowers the ability to move fast and make decisions with speed and confidence.
David Abshier

One of the most valuable commodities for any owner, developer or real estate professional is flexibility. For many firms, the best way to provide that flexibility is mezzanine financing. Mezzanine financing affords borrowers with the resources to move fast and to make time-sensitive decisions with speed and confidence, the freedom to pursue strategic opportunities beyond those approved by banks and other traditional lenders, and the ability to structure a debt relationship and financing program tailored to specific needs.

Fueled by a robust market for expansion and acquisition and a growing recognition for the added value that greater flexibility brings to development ventures, mezzanine lending has become an increasingly popular financing option in recent years. Occupying a middle level between senior debt and common equity on the balance sheet, mezzanine financing can bridge the gap between possibilities and reality, helping developers maintain the kind of responsive, agile and forward-thinking posture that will help them be successful in a competitive marketplace.

While the potential benefits of mezzanine lending can be profound, mezzanine agreements still operate under the same fundamental assumptions and requirements as with senior debt. In fact, mezzanine financing typically places mezzanine lenders in a first-loss position, and lenders are generally more likely to value clear, consistent communication and strong professional relationships when making financing decisions.

Establishing those relationships and trusted working partnerships helps mezzanine lenders minimize their exposure while providing borrowers with the greatest possible flexibility in their investment and development initiatives.

Relationship Building

How do lenders and borrowers forge those relationships and establish that level of professional trust? How do they get to the point where lenders can feel confident about the insights and ambitions of borrowers, and where borrowers can rely on the lender to provide them with the operational freedom to move into new markets or cultivate expanded opportunities?

From a borrower’s perspective, the fundamentals are really quite straightforward. While it may seem obvious, the single most important pillar of any financing relationship is communication. Close relationships are critically important in any successful mezzanine financing setup, and clear, open and honest communication between lenders and borrowers is the surest way to establish and maintain those ties. Because no lender likes surprises, and because very few transactions go exactly how both parties initially envision, maintaining open lines of communication at all times ensures confidence and consistency. While quality communication can never eliminate uncertainty, it can certainly help establish the necessary level of trust and understanding that will help both lender and borrower move past inevitable future periods of transition or uncertainty. It is a testament to the crucial importance of maintaining an open and honest exchange that it is not unheard of for mezzanine lenders to back out of existing financing relationships in situations where the level of communication was not meeting their expectations; even in cases where financial details and other supporting information were adequate.

Building a close, communicative relationship with a lender begins with the initial proposal and presentation. Every lender looks for organization, detail and clarity, and while the quality and viability of a borrower’s professional vision is always paramount, the ability to present a strategic agenda in clear, compelling and comprehensive detail can go a long way toward creating a strong foundation for future collaboration.

For smaller developers in particular, the quality of the initial presentation can be a vital and deciding factor. Making a positive first impression is always important when entering into a new relationship, but it is especially so for developers lacking an extensive track record of past successes. One of the biggest mistakes that any firm can make is to enter into a prospective first encounter unprepared. Whether presenting general data for an under-retailed market segment, or offering specific information extolling the potential for the redevelopment and repositioning of a specific site, the initial proposal is the opportunity to present a compelling, persuasive case. Site and firm history, strategy, nuance and achievability/feasibility should all be covered in depth. The more detailed and exhaustively researched the information provided, the more likely the lender will feel comfortable making a decision to move forward together.

Ultimately, mezzanine lenders are looking for partners, and a thorough, professional presentation with a convincing and clearly articulated vision can go a long way towards making that partnership a working reality.

One Size Fits All?

While mezzanine lending is a powerful and effective financing tool, providing many developers with the versatility, efficiency, and rapid response capabilities so vital in a rapidly evolving developmental landscape, it isn’t a perfect fit for everyone. Not all developers are eligible for a mezzanine financing arrangement, and not all projects are suitable for mezzanine financing and some developers may prefer to employ their own capital.

Those who do opt for a mezzanine component to their financing package should investigate their options carefully. Contrary to popular perception, not all mezzanine lending is the same. On a structural level, mezzanine financing can vary quite dramatically. Terms typically range anywhere from 2 to 10 years in length; loans can be recourse or non-recourse; and security, usually a membership interest, can be recouped via a variety of flexible financing alternatives. Cautious, prudent borrowers should always research their financing options and determine what lending framework fits best with their individual business plan or plans.

While the finances and agreed-upon lending parameters are obviously an important factor, the process of finding a good match between borrower and lender should take into account more than just the projected bottom line. The selection process truly does go both ways, and potential borrowers should feel comfortable approaching prospective lenders with a selective, proprietary mindset.

First-time borrowers in particular should interview at least three or four mezzanine financing entities to service their transaction, and all borrowers should expect consistency in personnel, philosophy and business practices. Savvy borrowers place a premium on proven experience, undivided personal attention and good communication. Borrowers and lenders alike should establish clear and mutually agreed upon expectations ahead of time, as well as predetermined alternatives and a course of action if those expectations are not met. Both parties are making an investment in each other, and up-front and ongoing due diligence is an important part of building and maintaining the relationship behind the investment.

The Bottom Line

For many lenders, that relationship weighs heavily in their lending decisions. Less a commodity than an ongoing professional partnership, a long-term relationship with a trusted lender can pay concrete dividends for all parties. Technically there is no “volume discount” in lending, but, realistically, the price-to-risk equation is always in play, and known entities generally tend to be viewed more favorably and are more likely to receive a positive evaluation. Other, more directly tangible benefits of repeat business and professional familiarity can include fewer up-front costs, expedited paperwork and credit approvals, and savings on other procedural expenses.

As a tool to expand opportunities, mezzanine financing is an increasingly prominent lending option. Unlike traditional equity and venture capital lending, where interested entities are more likely to exert influence over a deal, the inherent nature of mezzanine financing encourages significant borrower control. The best mezzanine lenders operate as engaged but passive investors, ready to lend a hand, but disinclined to interfere.

While it is usually only a small percentage of an overall lending structure, the flexibility, efficiency and targeted nature of mezzanine financing make it an invaluable asset for more and more firms. Developers who embrace that asset, and who work to successfully establish and maintain lasting and mutually beneficial relationships with mezzanine lenders can accentuate both their best practices and their portfolios with a valuable entrepreneurial edge.

David Abshier is senior vice president and managing director of Columbus, Ohio-based Huntington Capital Markets, a mezzanine and preferred equity provider. He can be reached by e-mail at dave.abshier@huntington.com.


©2007 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.