Mezzanine Investing: Private Equity ‘Lite’ or More Action for Less Stress?

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Mezzanine FundsNothing is as simple as it first seems – that applies to many pieces of the great jigsaw puzzle that makes up the financial world, and equity and debt are no exceptions.

They’re at opposite ends of the spectrum, and in between lies an entire world where ingenious financiers and lawyers have developed all sorts of techniques for making equity more debt-like, and debt more equity-like.

The technical term for much of this is not “magic,” but rather mezzanine investing.

Mezzanine falls squarely into that space between equity and debt, and has elements of both investment banking and private equity.

And it might just be better than either.

What is Mezzanine?

In a typical leveraged buyout, the private equity firm contributes its own equity (the cash it has on hand) and then raises debt from banks to cover the rest of the purchase price.

It’s just like buying a house: you front whatever cash you can for the down payment, and then take out a mortgage to cover the rest of the price.

With houses it’s fairly simple and (most) people only have one mortgage, but when you’re buying entire companies, often you need multiple different types of debt, with each one coming from a different investor.

Mezzanine is “in between” debt and equity in such a deal – mezzanine investors take on more risk than the normal debt providers, have a lower claim to the company’s assets, and expect a higher return.

“Mezzanine” itself is usually a more “junior” form of debt that can sometimes be converted to equity; sometimes PE firms themselves provide the debt and other times it comes from banks, but dedicated mezzanine funds provide the bulk of the loans.

I could go on about what mezzanine is and what it isn’t, but I recently had the chance to interview a Partner at a dedicated mezzanine fund – so you’ll get to hear all about it directly from the source:

Breaking Into Mezzanine – The Journey

Q: So, tell me about your journey. How did you end up in mezzanine?

A: I went to a good US school – not Ivy League, but still a good reputation – and then joined a US-based investment bank as an analyst in the M&A department.

I stayed on until I was promoted to associate, and as things were starting to slow down (in the last recession), I decided it might be a good time to do an MBA, so I went to Europe for that; I was in my mid-to-late twenties back then.

At the time my intentions were to get into PE; a lot of people go into mezz because they want to do PE and become a Principal there. If you do normal debt deals you feel very much like a lender, but mezzanine, with its fund structure, is much more like being an investor.

So there I was, looking at PE and researching it over the course of my MBA when I began to look more closely at mezzanine as another option. With mezz, you do largely the same work as PE, but you do deals with a much greater “frequency” as there’s considerably less portfolio management – at least when things are working as they should be.

It’s sort of like “PE-lite,” which was a great fit for me – as a former banker I didn’t have much operational experience and I didn’t want to be as involved operationally as you might be in PE. But it’s also not as impersonal or mechanical as being a senior lender, since you look at qualitative criteria as well.

They focused on deals, which appealed to me – I saw it as a way to become an investor while still ensuring that I could keep working on deals as much as I had in banking.

In mezz, you also piggy-back on the efforts of the PE guys quite a lot – you might sit as an observer on the Board, but as an observer you wouldn’t be taking an owner’s direct decisions.

This is a pretty standard state of affairs unless the company gets into a restructuring, at which point you may end up in an equity-holding situation. Otherwise, you get pretty much the same information a lender would get – monthly reports on points such as management accounts.

Q: Do you still find yourself wanting to do PE?

A: Actually I came to like mezz a lot – it’s much more diverse, not just in terms of volume of deals, but also in terms of sectors, geographies, deal sizes, and so on, whereas you tend to specialize in PE. I don’t think that would work for me now.

Q: What are the typical entry points into the field?

A: The standard path is to join as a post-MBA associate following prior experience at an investment bank in a team such as Leveraged Finance or M&A.

Some people enter after working for a year or two as analysts at investment banks – this is low-risk for the employer since it’s inexpensive and it’s not such a big deal to train them.

But they don’t want someone straight out of university – from that year or two in banking, candidates gain confidence with modeling, valuation and how the practice of a buyout works.

So M&A, Leveraged Finance or Corporate Finance are all good, but someone from, say, Equity Research, would be less suitable – their models aren’t as deep, and we want people with deal experience, partially for the obvious reasons, but also because they’ll know the realities of a work style that involves peaks and troughs.

For the post-MBA associate, we look for more or less the same qualities – ideally someone who was an analyst at a PE firm or mezz house, or perhaps in distressed debt.

We’re not so interested in consultants with MBAs – they work better in mainstream PE where the operational skillset is more important; we want modelers more than PowerPoint jockeys.

But across the board there seem to be fewer consultants than bankers in PE, with the exception of the German-speaking world. Typically we see more interest from people with M&A and Leveraged Finance backgrounds anyway.

A Day in the Life of a Mezzanine Investor

Q: Speaking of peaks and troughs, what are the hours like? What’s the typical rhythm?

A: The work is deal-based, so you can have flat periods but then you could have two big deals come along at the same time.

On top of that, there’s monitoring the portfolio, which is generally steady and quite light work, but if something blows up then that’s a huge spike in working hours.

So it’s not investment banking – not as extreme as M&A – but it’s more than your typical 9-to-5. So perhaps 9-to-7 in calmer times, all the way up to the full all-nighter when deals heat up.

Q: So what’s the day-to-day nature of the work? How do you raise funds and source deals?

A: As with any fund-based business, everything starts with raising money from investors. This is largely the same as PE – you put together the materials and go out to meet Limited Partners.

An analyst might get involved with putting together the Private Placement Memorandum and presentations, and the more senior staff will be on the road meeting with potential investors.

Once you raise the funds, the next step is sourcing deals, which is primarily a matter of leveraging relationships with PE firms and senior lenders.

You want to be their first call for mezzanine financing, so that involves a lot of networking – networking is important across everything in Leveraged Finance, but for LBO-mezz “networking” consists of meeting with sponsors and lenders, and less so with M&A advisors and the contacts that first bring in the deals.

That’s different for sponsor-less mezzanine players (they’re relatively small in number – examples include Mezzanine Management or MML Capital) – or “networking” will be a smaller area of focus for a larger player like ICG.

Q: So now you have the funding and the deals – what’s next? What exactly do you do on a deal, and how is it different from normal PE?

A: Once the deals come in, you need to do the analysis.

It’s the same sort of analysis that you’d expect at a PE sponsor, but with the advantage of being somewhat prepackaged.

“Prepackaged” just means that when the opportunity comes to you, other parties such as the consultants, bankers, accountants, and lawyers have already done serious due diligence work.

So you get to piggy-back on their work and save a lot of time, which results in lower expenses – but that can also mean lower management fees paid to mezz funds.

The analysis still involves a lot of financial modeling; we need to do plenty of sensitivity analyses to work out how much of a ‘blanket’ we’ll have in different scenarios – financial, operational, macroeconomic, and so on.

Naturally this affects how we structure deals – and of course when structuring such a deal, we often need to negotiate with the other parties, although occasionally we do this on a ‘take-it-or-leave-it’ basis. The legal points are then sorted out once we agree on all the commercial elements.

Q: OK, so essentially if you like modeling and analytical work but you don’t like due diligence or the operational side, mezzanine is a great fit for you.

What about once the deal closes? How much portfolio monitoring do you do?

A: This part is relatively smooth unless there’s a problem – we might review the monthly management accounts, meet with the executives at least once a year, and go to quarterly Board meetings.

When there is a problem – such as a covenant breach or the need to refinance (whether as a restructuring or simply as part of an acquisition by the portfolio company) – then we put in a great deal more effort.

We’ll need to revise and update the model, negotiate with all the stakeholders, and if things get ugly, also negotiate terms with the Restructuring advisors or the buyers of distressed assets.

In the latter case, when people start taking haircuts or when sponsors walk away we’re not automatically in the sponsors’ role as the next-in-line – sometimes a distressed investor will step in to fulfill that role.

So you hope that you don’t end up in these situations, but you need to protect yourself and be prepared for the possibility via appropriate attention to the deal structure and the legal side.

Q: What sort of person tends to thrive in mezzanine investing? Is it just what we discussed before – someone who enjoys modeling but isn’t as interested in the operational side?

A: It’s similar to what’s required to do well in PE; it is less high-profile, though, so you need to be sure that you’re happy with that.

The work itself can be similar, though, so you need to like being close to the action and not just sitting in an office.

It’s social since you spend a lot of time out in the field, but you also need to like the analysis and doing the analysis in a flexible way that lets you look at different scenarios.

That’s a consequence of the greater variety in investment types, meaning that the process is less formulaic. It sometimes appeals to bankers who want a more entrepreneurial environment than what they’d get working at a bank – similar to what you might see in other fund-based businesses.

Q: How are mezzanine firms structured and how much do you get paid?

A: Very direct, I like your style!

The structure is similar to a PE firm, so you’ll see positions for Analyst, Associate, Director and Partner, possibly with some ranks in between.

In my organization the ranks are a little blurry in terms of responsibilities, but generally an analyst won’t get carry, and associates may or may not depending on the firm.

If you don’t get carry, you need to make sure you’re on Partner-track (and if you’re a post-MBA associate, you definitely need to be on Partner-track) – this isn’t banking where we have outsized bonuses, so the main reward comes from the carry.

The base salaries range from around £60k (~$100K USD) for analysts up through £100k (~$165K USD) for the Partners, and the bonuses might range from 30% to 100% of those base salaries.

But the real upside is in the carry, which can be significantly more than your normal bonus depending on the firm’s performance.

In short, base salaries are roughly the same as in PE but lower management fees mean that bonuses aren’t quite what you’d receive at a standard PE firm; of course, that’s balanced by the fact that the hours are often better and that you spend most of your time working on real deals.

Regions, Exit Opportunities, and the Future

Q: How does mezzanine investing differ in other regions? We’re both based in the UK, but I’m assuming mezzanine differs elsewhere?

A: In the US and at some European mid-market funds, you’ll see more regional specificity – these more focused firms sometimes act more like conventional PE firms in their focus and with their increased involvement with portfolio companies.

There are some global firms in the middle market too, and some firms specialize in sponsor-less mezz, but increasingly – across many firms in the wider buyout world – there is a widening of focus by the big players to embrace asset strategies beyond PE, which include mezzanine as well as various credit funds.

Q: What are the exit opportunities in the field?

A: People tend to stay rather than “exiting.”

Some people are leaving now as they’re being forced out or because things are looking less attractive, but when the industry is doing well you tend to stay on the escalator.

It’s rare for people to move back to banks – they tend to come in and stay in, and if they do well they’ll go off on their own and raise their own fund. Occasionally people will go into funds of funds or PE, but that’s quite rare – usually it’s the other way round, and quite a few PE analysts and associates move into mezzanine each year.

Q: Any last words of advice to readers considering mezzanine?

A: Be sure that you’re in a fund that has a good track record and that the market and specific fund dynamics will enable them to raise their next fund.

It’s a fund-based business and if there’s no money you can’t invest, so be certain that your firm – as in PE – can get through both tranquil and turbulent times.

Q: Great – thanks very much, it was really helpful to chat with you.

A: No problem – I’ll see you soon!

About the Author

is the author of How to Find a Graduate Job. He hopped from anthropology at UCL to private equity and then to a Bain-spinout strategy consulting firm. He has brokered relationships between entrepreneurs and early-stage investors, produced top finance events in Europe, and currently works at a startup.

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40 Comments to “Mezzanine Investing: Private Equity ‘Lite’ or More Action for Less Stress?”

Comments

  1. K says

    I’m surprised partners’ salaries are so low – 100K base plus 100% bonus (high end of the range) is lower than similar positions in other high-paid industries. Can you confirm this is indeed for partners, not directors?

    • says

      I think there’s a lot of confusion over carry vs. bonus for positions on the buy-side and how compensation is split between them – my understanding for mezzanine is that while bonuses are lower, carry can actually be very good and much closer to what you see in PE and so on. All things considered, Partners probably make a bit less than in PE but 7-figure pay is still possible at that level when you factor in carry.

      Bonuses are more of a concern for junior-level people since they (usually) don’t receive carry anyway.

    • M&I - Don says

      The partner I spoke to did give the impression that those more senior salaries would likely vary quite a bit between firms (particularly between newer and more established outfits), but as mentioned by Brian and others the real money is in the carry.

  2. PE / Mezz says

    Great post. I work for a global mezz house. The money is in the carry but you won’t see it for years. You are def well remunerated from a base salary + bonus perspective. Hours are transaction driven – you have days where you leave the office at 6 and days where you don’t sleep. Very interesting work and given that deals can be structured debt, hybrid or more equity like, you need to think quite creatively. We’re also doing a lot of traditional PE deals now (growth capital / sponsorless), which is mostly a function of where the market is at. Most people are ex-private equity, leverage finance and m&a backgrounds. We also have a lot of lifers, which probably reflects the carry structure.

    • says

      Thanks for sharing! That definitely clarifies some of the points within. And yeah, it definitely sounds like more of a “lifer” industry than IB or PE due to the pay structure.

    • M&I - Don says

      Thanks for the feedback – glad you liked it! Interesting point you make on the sponsorless; the interviewee said that he saw relatively little of that in the UK / Europe, and probably more Stateside – I wonder if that tallies with anyone else’s experience?

  3. K says

    Great post Don – very helpful! I recently had interviews with mezz shops and everything covered in your interview was consistent with what I picked up from meeting the firms, and from a prior discussion I had with an alum at a mezz fund.

  4. A says

    How do “traditional” Mezz shops (GP/LP structure) compare in terms of deal type, junior comp, senior carry, hours etc with BDCs (Ares, Apollo, etc)?

    • says

      Not really sure on that one – if anyone else knows, feel free to chime in. If I had to guess, I would say BDCs would probably be above mezzanine pay and work hours but also below traditional PE but that might be off.

  5. says

    Hi,

    Is it possible to get into mezzanine finance straight after university?

    Do the analysts in mezzanine finance really earn 60k (GBP) in base salary?

    I thought that 1st year analysts at bulge bracket banks currently earn around the 45k mark for base salary in the UK so it suprises me that analysts in mezzanine finance earn significantly more.

    • says

      It would be very difficult to get in right out of university unless you had significant PE / M&A / LevFin experience (e.g. multiple internships in those). And yes, the salaries are accurate for the UK. The base salaries are higher than first year IB analysts because you need more experience to get into mezz and come in at a more senior level.

    • M&I - Don says

      Brian’s spot on about this – the interviewee did emphasise wanting that year or two of bank experience. As in PE, with such lean team structures it’s not a good use of the seniors’ time training people up in the basic skills. The higher salary reflects this.

  6. Hoa Tran says

    Thank you so much for your post! It’s really helpful for me to make a direction of future career in fund management. I have been really interested in PE after graduation, but now mezz investing gives me another view. But I really appreciate if you could tell me more about the mezz investing prospect in emerging markets in the next few years.

    • M&I - Don says

      Spotting the direction of mezz investing is quite interesting – the industry can get buffeted by all sort of factors. Mezz is quite expensive compared to debt, so any environment where debt is limited or lends at lower multiples will provide better pickings for mezz funds. Conversely, recently in Europe a surge in cheap debt available in the form of high yield bonds has caused the mezz guys big headaches, forcing them into lower mid market deals, although the latest bout of market uncertainty has mitigated that. Also, unlike PE funds which are very often much more regionally specific (for practical operational reasons), I’ve seen mezz guys with mandates spanning multiple continents, so funds in the the States and Europe are already actively participating in emerging markets.

  7. hunjsuk says

    Another great article, I’m really looking forward to more Private Equity and Private Equity related articles, like the upcoming Private Equity in Emerging Markets one. Can you name any specific mezzanine fund firms that just deal with mezzanine funds or offer Mezzanine Capital? I know for example Blackstone Group has a division that deals with Mezzanine Capital and has Mezzanine Funds, however I don’t know any firms that only have Mezzanine funds or were specifically founded for operating Mezzanine Funds or offering Mezzanine Capital in the US, Canada or in Europe.

    Also what is the difference between Growth Capital (that firms like Summit Partners and TA Associates provide) and Mezzanine Capital? Are there any plans to publish an article on Growth Capital with contributions from employees at Growth Capital providing firms such as Summit Partners or TA Associates?

    • says

      Not sure about the first part as I think most of the mezzanine places are parts of other firms, as in the Blackstone example you mentioned. Someone else with knowledge, feel free to answer.

      Growth capital vs. mezzanine capital: mezzanine is more of a debt-like security for mature companies that can support interest and principal payments and is often the riskiest part of the debt in a buyout. Interest rates tend to be higher than other forms of debt.

      Whereas growth capital is really for fast-growing companies that aren’t necessarily that profitable, and almost always comes in the form of equity rather than debt or debt-like securities such as preferred.

      Places like Summit and TA might find a promising startup doing $30-$50MM per year in revenue, value them at a certain range, and then inject capital to fund their future expansion and acquire a stake in the company.

      We do want to publish something on growth capital, but it is actually very similar to VC which has been featured here before. But I will add it to the list and see if anyone could contribute.

      • hunjsuk says

        Thanks Brian your reply was very helpful. If Growth Capital is very similar to Venture Capital then why dont more Venture Capital Firms offer more Growth Capital, why is it specific firms like Summit Partners and TA Associates? Is late stage Venture Capital virtually equivalent to Growth Capital ?

        Also you said “and almost always comes in the form of equity or debt-like securities such as preferred” what does preferred mean? Preferred stock? Preferred Debt?

        • says

          Preferred stock. And yes late stage venture capital is very similar to growth capital. Firms are starting to do everything and invest across all stages so you will see more convergence.

  8. SS says

    Guys this is great, definitely incredibly helpful. In one of your next posts please consider doing a similar piece on growth equity. Thanks.

    • M&I - Nicole says

      This link should help http://www.weil.com/news/pubdetail.aspx?pub=8947

      In contrast to most private mezzanine funds, BDCs are a permanent pool of capital for private equity firms to invest in loans to middle market companies. Private equity firms typically raise new capital every four to six years. When loans made by the BDC are repaid, the BDC distributes the income and retains the capital for future investment, thereby doing away with the need to continually raise capital.

  9. morange says

    Brian, thanks for referring me here. Just jumped out of a phone interview with a sponsor-less credit-oriented fund player(They do mezzanine and senior secured debt financings mainly, but will also collaborate with the PE fund under the same firm, which doesn’t happen very often though). Fairly close to what the article has described here: deal-focused,diverse, no industry focus and flat firm structure.

    Second round would be an on-site LBO test. We’ll see how it goes.

      • Wass says

        Hi Nicole.

        I was unaware as to whether this thread is still active. I was wondering as to why the interviewee did not provide a deeper analysis into exit opportunities? I would like to know how difficult it would be to move into PE/IBD from Mezz.

        Overall, great website!

  10. AB says

    What’s stopping such shops from using a bit of fund leverage to get to all-in returns at par with PE shops? If straight credit funds can do it, so can mezz shops?

  11. HK says

    This is really helpful. Thank you so much!!!
    I have a question regarding this career path. I am an equity analyst and have built almost 8 years of experience working at couple of global top US houses. As of now, I quit my job and will be taking MBA programme in europe. My questions is.. as an experienced equity analyst already in mid-level, is it possible to enter this field after graduation? The major reason I’m taking a career break and going MBA (finance) is to change my field, while the case will be pretty much similar to others as well…
    Any comments are appreciated.

    • M&I - Nicole says

      Yes it is. Even though your case maybe similar to others, it really depends on how you spin the story too.

      • Ryan says

        Thank you for the information.Being a fortunate enough undergraduate at a target school, I have an upcoming interview with a mezz fund. Could anyone provide me with some potential interview questions/cases/problems? If someone is kind enough to answer this today, it would be invaluable.

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