In this lesson, we're going to talk about a category of financing that is somewhat more obscure, and that is mezzanine financing. A mezzanine is that intermediate level in a building between the ground floor and the the occupied space in the levels above. In the financing context, it's the same sort of idea. It's an intermediate level that exists in some capital structures between the the debt and the equity sections, and in fact incorporate some financing instruments that may have characteristics of both debt and equity sometimes referred to as a as a hybrid instrument. Now, the types of mezzanine financing can can vary widely, everything from an unsecured debenture or a note payable to debt with detachable warrants to convertible debentures insurers to convertible preferred shares. The dimensions of each of these instruments will vary in terms of the conditions and the costs, depending on the context of the situation.

So in this lesson, I'm just going to try to hit a few highlights of some of these terms and conditions. Let's start by reviewing some of the terminology. a warrant is the right to purchase a certain number of shares of stock or bonds at a given price for a certain period of time. Whereas a convertible instrument is convertible by the holder into common shares at a predetermined rate. The cost of mezzanine finance is an increment above your senior debt. The lower end of the coupon range begins somewhere at the higher end of the senior debt end range and goes up and can go up significantly from there.

Now warrants are awesome. refer to as equity kickers or we may have instruments with equity participation features embodied or embedded within them. And these give investors a nice upside if the financing they provide proves to be helpful in propelling the company forward and executing their business plan. The interest payments may be your typical monthly, quarterly semi annually or sometimes annual payments. Usually these are done in cash, but not always with a mezzanine instrument. In fact, interest might be accrued and only paid at the maturity of the instrument or sometimes the interest may be even payable in common shares of the company.

The terms of repayment are flexible, but are often longer than the term associated with the the senior term debt. Now, this may require a lump sum payment at certain points throughout the term of the the instrument or so. times at maturity commonly referred to as bullets or balloons. security for these instruments is fairly limited. And a rule of thumb that you can use to possibly gauge how much mezzanine financing might be available is that you can generally once again returned to that rule of thumb of using your EBITDA. Often you can get another one to two turns of EBITDA or set another way, take your trailing 12 month eba and multiply it by one to two to determine kind of the maximum amount of mezzanine financing available.

And the last feature of mezzanine financing instruments is that they're generally covenant light. And for this reason, you'll see that the cost of these instruments is significantly higher than, say senior secured debt. So let's just close this module by reviewing some of the advantages and disadvantages of mezzanine financing. advantages include financing that tends to be more flexible than senior debt because there are these fewer covenants associated with the instruments. mezzanine financing tends to replace what would otherwise be equity financing, and equity financing is always going to be your most expensive source of financing. So instead of issuing common shares, you issue some mezzanine financing and you optimize your capital structure in that way.

Now, the disadvantages of mezzanine financing are, first of all, that there's an incremental and possibly significant cash flow burden associated with these instruments. mezzanine financing has been put in place a lot of private equity deals over the years. And this high degree of debt leverage leaves little margin for error or volatility in the operating results of these companies. This tends to explain Both these companies to high degrees of insolvency risk. Now one of the companies I'm involved with, we issued some convertible debentures to pay for one of our acquisitions. So I'm just going to walk you through our thinking when we made that decision.

Our thinking at the time was that issuing shares at the current share price will be too diluted to our shareholders. And while we had sufficient availability under our senior secured facilities to pay for the acquisition, it really would have left us with a little wiggle room on our credit facility for anything else that might come up. So by issuing these convertible debentures, we were kind of trying to balance these two ends of the spectrum off. So in the end, we ended up issuing these convertible debentures at a conversion price that was about 25% higher than our current trading price. The debentures themselves had a 7% coupon payment associated with them, and so on. And this was believed to be and still Now a couple of years later, I think was probably the most balanced approach for dealing with paying for the acquisition, you know, taking into consideration these, this balance between diluting our shareholders and being too risky and too aggressive on our financial leverage.

So in our next lesson, we're going to begin looking at the different types of equity investors and their expectations. Until then,