DAD in The Globe And Mail:
enterprise.theglobeandmail.com
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Mezzanine financing bridges gap for mid-sized firms
WHO'S INVESTING IN WHAT
Friday, December 4, 1998
DAWN WALTON
The Globe and Mail
David Murray and his two partners hoped to take a big bite of Canada's
premium ice cream market when they founded Delicious Alternative Desserts
Ltd. two years ago.
They already owned a dairy in Stoney Creek, Ont. But they wanted to convince
purveyors of high-quality treats, such as Ben & Jerry's Homemade Inc., that their
tiny firm should win manufacturing and distribution rights across Canada.
"In the fall of '97, we started bidding for the rights of Ben & Jerry's, not thinking
that we'd get them because we were such an infant company," Mr. Murray
recalls.
The folks at DAD -- short for Delicious Alternative Deserts -- found they needed
some hefty financing to back their dream to offer Canadian consumers flavours
such as "Cherry Garcia."
DAD captured some conventional venture capital backing to support the
enterprise, but the company also tapped into the mezzanine financing market.
To support the Ben & Jerry's deal, which became official in May, DAD raised
$3.5-million in mezzanine financing from four institutional investors with the bulk
coming from Bank of Montreal Capital Corp. and First Ontario Labour
Sponsored Investment Fund Ltd.
Mezzanine financing, also known as quasi-equity financing or subordinated debt
lending, is a growing source of funding for mid-sized companies that have solid
cash flow but little tangible security.
DAD's cash injection is among the 193 mezzanine financing agreements
completed in the first half of the year and included in a survey by Toronto-based
Macdonald & Associates Ltd. Those reported agreements totalled $109-million.
This kind of investment gives smaller Canadian companies an option beyond
traditional debt and equity financing. Many companies already have senior debt
on their books, but this funding allows them to raise more money without giving
up a big ownership stake.
Mezzanine financing isn't new. Bank of Nova Scotia's subsidiary RoyNat Inc. has
been providing subdebt since the mid-1980s.
"When we first started doing it, I think we were a bit of a lone wolf," says Earl
Lande, RoyNat's senior vice-president.
The number of players has grown as a result of increased demand.
"There are a lot of entrepreneurs who own companies who really don't want to
give up equity, but just don't qualify for a conventional term loan. But they've got
good companies. They make good cash flow," Mr. Lande says.
These deals fall somewhere between secured debt and equity in terms of risk.
But because the loans are not generally secured by any assets, the interest
rates are higher. Rates can range from 15 to 22 per cent, according to
financiers.
Some observers say mezzanine financing is also becoming more popular with
companies as well as with investors hoping for higher returns. Because of the
risk, the deal may also involve a small equity stake -- called a kicker -- or
royalties to tap some future cash flow.
In DAD's case, the lenders have attached a performance criteria to lower the
interest rate and to receive an equity kicker at the end.
"If it's not as successful as we think it's going to be, then it protects them [the
lender]. They've got some sort of a built-in reward that they're comfortable with,"
Mr. Murray says.
Ontario-based companies received the bulk of the mezzanine financing during
the first six months, according to the Macdonald survey. Eighty companies in
that province captured about $44.4-million in subdebt, while 60 firms in Quebec
received about $24.1-million. Fifteen Alberta-based companies shared about
$17-million in financing while eight outfits in Manitoba split $12-million.
By sector, computer-related businesses were the most popular, with 40
recipients of subdebt. Others preferred areas included manufacturing, with 38
companies, consumer-related, 24, and medical- or health-related, 15.
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