Middle market companies (with revenues between $50 million and $1 billion) and lower middle market companies (with revenues between $5 – $50 million) that are not able to access today’s high yield bond market are increasingly turning to smaller regional banks for their capital needs. When a bank is unable to provide adequate capital, these companies will typically seek additional mezzanine financing or a unitranche facility. Mezzanine debt sits between senior secured bank debt and equity in an issuer or borrower’s capital structure, while unitranche facilities spread across the debt capital stack. Typical uses of proceeds for companies seeking this kind of capital include: financing leveraged buyouts, recapitalizations, corporate acquisitions, or growth capital as an alternative to public or private equity. The need for middle market companies to acquire capital outside of banks has increasingly shifted investor focus towards middle-market debt funded through non-bank lenders, but not to the level that one would expect. This is particularly true when it comes to investors considering the benefits of investing in the asset class such as less volatility, higher returns, and less risk.
Lack of activity in the space could simply be attributed to the fact that it is somewhat difficult to access…So how do investors get in?
As touched on in an earlier post, “Options for Raising Debt in the Lower Middle Market,” the main ways to connect with this type of investment is through a direct lending agreement[i], a pooled private-fund structure[ii], , or a business development company (BDC)[iii]. These options, generally speaking, are very expensive or have long lock up periods. CrowdOut seeks to provide a viable alternative and provide investors access to this high-yield opportunity with minimal fees.
As compensation for lenders subordinating their positions on the capital structure, payment structure for investors is such that they are paid quarterly (or in CrowdOut’s case monthly) in cash, reducing the overall volatility of returns to investors. In addition, these companies are often sponsor-backed and those sponsors incentivized to maintain solvency. Coupon rates today are historically low, but for investors seeking yield in a low-yield environment, this kind of debt is extremely appealing. Fixed rates, commitment fees and robust covenant packages also contribute to higher returns, typically averaging 125 basis points higher than their broadly syndicated counterpart for investors by keeping companies from grossly oversizing their expanding and borrowing appetite. Middle market companies by nature are more tightly knitted through families, founders, or private equity groups. Alternative lending is done through private negotiations and extensive due-diligence that allows the loan to be structured in such a way that is more conscious of underlying business idiosyncrasies.
Characteristics of middle market loans make them poised for profitable returns in the current market when accessed and examined properly. CrowdOut opens the door to this asset class and seeks to help investors have more control, transparency, and flexibility when it comes to their capital.
[i] A negotiation between borrower & lender, requires large amounts of capital
[ii] A mutual fund type structure with managerial fees and lack of decision in where the money is placed
[iii] Closed-end investment companies that sell equity shares to investors