The Rise of 2nd Lien Lending to Fill the Void in the Credit Markets
Published on the Commercial Finance Association Blog: http://commercialfinanceassociationblog.com/2015/10/08/the-rise-of-2nd-lien-lending-to-fill-the-credit-void-in-the-credit-markets/
Second lien debt is a unique product that seeks to fill the void in the credit market created by limitations of formula-based senior lenders and parameters and term of traditional mezzanine lenders. Companies across America have a symbiotic relationship with their bank while at the same time still need additional credit. There exists few options (outside of shareholder loans and vendor financing) for subordinated borrowing except traditional 3-to-5 year mezzanine financing that is only available to select few companies that typically have a minimum EBITDA of $8 mm. This solution provides a long-term solution, but does not address short-to-medium term needs.
Traditional mezzanine and equity are the two institutional forms and both serve as long-term permanent sources of capital. Healthy and stable companies are able to access both forms at competitive market rates through efficient processes, but many companies have alternative needs and generate less than $8 mm of EBITDA. They also have interim, immediate or seasonal needs that, if solved, will help position them for the right long-term capital solution. 2nd lien debt is alternative to traditional mezzanine and equity capital as it is secured and fully amortizing.
The 2nd lien debt, which is fully amortizing, is meant to offer a short-to-medium term subordinated capital solution for companies experiencing rapid growth, a turnaround, seasonality or general availability. It also serves as a great stretch piece for acquisition financing. The loan is secured with a 2nd lien behind the senior lender and covenant free or lite depending on credit with no equity or warrant requirement.
The ideal 2nd lien borrower is an institutional company with sub-institutional capital needs ranging from $500k to $5 million. Companies have a range of easy options to solve for a several hundred thousand dollar capital need as well as a $5+ million capital need, but very few alternatives to solve for a few million dollar capital need that is subordinated to an existing lender.
2nd lien financing is short-to-medium term in length and meant to position companies who want to obtain permanent mezzanine capital, sale to private equity or short-term working capital solution. Typical terms range from 12-to-36 months and enable companies to position themselves for the right long-term capital event or solve short-term needs due to rapid closing times.
Broad Uses of Capital
Capital needs vary across industries, but there remains a strong need for flexible capital that is accretive and covenant free. Most companies, especially owner-operated ones, have needs that constantly surpass what their bank is able to provide. Common uses for 2nd lien capital include availability, seasonality and acquisitions where the owner seeks flexibility and does not want to give up equity. This type of financing enables companies to achieve their desired growth and de-lever or enhance profitability to make them an attractive target for private equity.
Timing Related Senior Debt Deals
A by-product of 2nd lien financing is bank kick-outs and timing related senior debt deals. Companies often times are not able to obtain consent to take on subordinated capital and find themselves in a cash crunch. Loan purchase assignments provide a unique alternatives to quickly and safely exit a bank in order to obtain a larger financing for one trade cycle and obtain a new bank once working capital normalizes. This type of transaction is becoming more accepted, but needs to be done by experienced parties.
Charlie Perer is a Director at Super G Funding and a member of the Firm’s cash flow lending credit committee. Founded in 2008 and based in Southern California, Super G Funding, which specializes in lower middle market senior and subordinated cash flow and residual loans, recently closed a $100 mm committed debt fund with the goal of filling the credit void in the lower middle market (revenues under $100 mm). Super G is a market leader in providing 2nd lien loans to companies who have additional capital needs beyond what their existing senior lender is willing to provide. This unique product is tailored to companies who have an existing senior lender, can demonstrate sufficient cash flows and are looking for an accretive capital solution.