“What is the current status for lower middle market (and smaller) mezz?” - nobody, ever
It’s time for a thread!
Over the last 10 years, “private lending” has become a popular place for pensions and endowments to invest.
~$120 B a year may not sound terribly impressive compared to the PE/VC headlines but compared to the $40B raise in ‘11 fundraising tripled in a decade
Why? Yield.
On the micro level, it feels like everyone has raised a new fund at 2-3x their previous fund size.
This has pushed minimum investment sizes up. If a fund was looking to invest $5-10 Million per deal they are now looking to invest $15-25 M per deal.
Similarly, look at the players in the leveraged loan market now.
This has two implications, IMO:
1) The smaller end of the market ($1-5 M investment size) has actually been partially abandoned.
2) The larger part of the market is following other sectors and becoming more about asset gathering rather than investment selection.
Most managers play the equity lottery. Their incentive comp structures are such that they would prefer to take part of their return through equity kickers like warrants.
So deals tend to get priced at 10-12% plus equity. The manager clips coupons waiting for the equity to pay
Now, fast forward to 2020, and the emergence of PPP. EVERYONE took it. @stevenmnuchin1 was basically:
I’m fine with this, but there were two effects:
1) For the business owner it dramatically skewed perceptions of what the cost of capital is.
2) Dramatically evened the playing field between economically viable companies and those that aren’t.
So, what was my response? I basically took the summer off to let the dust settle.
So, where are we now?
A) Conversations have picked up dramatically.
B) I don’t know if it’s because people want to get things done, or whether they are just tired of 6 months of lockdown.
C) It feels like commercial banks are pulling back
IMO, here’s where current pricing is:
A) If you need $15+ M then pricing is probably still 8-10% plus warrants
B) Need $7-15 M? Probably 11-13% plus warrants or mid/high teens w/o
C) Need $1-5 M? Probably still mid-high teens.
Final note: I’ll use this picture again showing then high percentage of “Cov-light” leveraged loans. That is NOT the case in the mezz market.
I spoke with another mezz investor yesterday who said they are increasing collateral protections (covenants, PG’s, etc)...
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