Mezzanine Financing

List of Contents

List of Figures

List of abbreviations

1 Introduction
1.1 Executive Summary
1.2 Scope of work

2 Problem and Research
2.1 Problem definition
2.2 Relevance and motivation
2.3 Methodology

3 Relevant Theories
3.1 Principal Agent Theory
3.2 Transaction Cost Theory
3.3 Property Rights Theory

4 Financing via Mezzanine
4.1 Definition
4.2 Characteristics
4.2.1 Mixed form
4.2.2 Debt capital related components
4.2.3 Equity related components
4.3 Application of Mezzanine capital

5 Benefits of Mezzanine capital

6 Conclusion

Bibliography

Appendix

ITM Checklist

List of Figures

Figure 1 - Risk/yield relation curve of hybrid forms of finance

Figure 2 - Coverage of Mezzanine capital

Figure 3 - Company value enhancement through Mezzanine

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

1.1 Executive summary

The term Mezzanine resounded throughout the land. Mezzanine financing instruments, which represent a mixed form between equity and debt capital, are considered as the financing alternative particularly to medium-size enterprises, whose financial situation substantially worsened due to the difficult overall economic situation in the last years.

Particular with regard to Basel II and the more restrictive granting of loans lead to an intensification of the situation due to the fact that German medium-size companies traditionally have a little equity ratio which is however relevant for their rating and thus make it difficult to revert to the financing practice of the house bank so far.

In order to improve the equity situation, Mezzanine financing instruments can be used, which are at least economically assigned to equity depending on the definition during the rating process.

This assignment however primarily addresses the issue of economic aspects of the financing instrument which have relevant influence on the representation of the balance sheet.

1.2 Scope of work

The assignment Mezzanine financing starts with the introduction which includes the executive summary and the scope of work that is realized in here.

The second chapter deals with a detailed definition of the problem that causes the relevance of this assignment, the determination of the objectives as well as the methodology that describes the assignment’s structured procedure.

Chapter three is focused on the underlying theories of Mezzanine financing. At this juncture in particular the principal agent, the transaction cost and the property rights theory according to Mezzanine financing are being analyzed.

Chapter four is about basics, typical characteristics and the application areas of Mezzanine capital whereas the chapter five deals with the benefits of Mezzanine capital.

Finally, the results of this assignment are summarized; especially whether the set objectives are reached as well as critical comments about the assignment are given in the last chapter.

2 Problem and Research

2.1 Problem definition

The financing situation for medium-size companies substantially changed in the past years. For many companies the bank loan so far formed the emphasis for the covering of capital requirement. This loan capital nevertheless represented the most favourable financing form.

For medium-size businesses this source of finance became increasingly problematic. The regulations of the Baseler committee for state supervision of banks, generally known as Basel II, contain a stronger risk adequate loan conditioning.

Despite the situation on the debt market, the provision of equity also became more difficult. The possibility of equity provision via the stock exchange appears unrealistic with regard to the capital market surroundings which show no acceptance for new IPO’s. For the admission of Private Equity, the claimed requirements often can not be fulfilled.

Due to the fact that many medium-size companies could only limited use self-financing instruments e.g. the retention of earnings mainly because of depending market conditions, alternative financing instruments come to the fore.

An alternative and flexible financing form is the hybrid Mezzanine financing. With Mezzanine capital companies are provided with financing instruments which appear suitable to meet the individual interests. In practice however, they are used only rarely.

2.2 Relevance and motivation

According to arising difficulties in raising capital, new financing forms are essential requirements from managerial point of view.

This change requires a stronger orientation of business enterprises towards optimized financial structures in order to create a lasting added value for the enterprise.

In order to meet these requirements, the primary objective of this assignment is to explain Mezzanine capital as a financing form. The interest of involved parties regarding the company’s financing are analyzed. Furthermore, an examination was done whether Mezzanine capital is suitable for solving financing problems of medium-size companies.

2.3 Methodology

In general, data researches are clustered into two groups:^[1]

- Secondary Research
- Primary Research

On the one hand, the secondary research is based on already existing literature. The primary research or the so-called field research raises data and information on the market originally - starting point for the data collection is the origin respectively source of facts and opinions.^[2]

Due to time restrictions this assignment is only based on secondary research which is particularly about the arising problems that causes the relevance of that assignment.

Today, medium-size companies have increasingly problems with various sources of finance. This is the main development which causes the growing importance of well implemented and managed financing structures for corporate value creation.

In addition, the objectives of this assignment are defined: Primary, these are the explanations about the significance of Mezzanine financing as well as a critical analysis about the necessity.

3 Relevant Theories

The neo-institutional finance theory deals with the explanation of institutions and financial relations, i.e. it concentrates on the question, to what extent and under which institutional conditions an approximation to the neo-classical finance theory of the perfect and complete capital market can be found in reality.

The purpose of the neo-institutional finance theory is the determination of the capital market equilibrium under information asymmetries.

Due to the advanced development of the information and communication technology sub-markets certainly exist which approach ideal market conditions, nevertheless it remains undisputed that the capital market is to be called imperfect.

To add is the existence of financial intermediates as well as different financing and legal forms, which are not explicable on the basis of the assumptions of the capital theory.

However in practice the financial intermediates are of crucial importance. An explanation for this can be found in different levels of information with regard to investors and capital seekers and the often unequally distributed possibilities of contracting parties to make decisions concerning the capital appropriation.

In fact the neo-institutional theory developed three fundamental directions, which also have affected the development of corporate governance (principal agent theory, transaction cost theory and the property rights theory) which will be explained in the following three sections.^[3]

3.1 Principal Agent Theory

In general, the principal agent theory identifies the agency relationship in which one party, the principal (capital provider), delegates tasks to another party, the agent (capital seeker). Within the scope of a corporation the owners are e.g. the principal and the directors are the agent. A capital seeker (agent) stands the chance to behave, deviating from the target agreements, in such a way (relating to the opportunism or self-interest of the agent) that he harms the capital provider (principal). The agency theory is occupied with the existence of control and incentive problems during asymmetrical information distribution between principal and agent. Basically the principal and agent are independently trying to maximize their profit. However for the principal there is thus a risk of disadvantages by the actions taken of the agent. Due to the closeness to the operational business the agent has a knowledge lead over, which is used for his own benefit. In practice the principal is at disadvantage because the agent has more information. This case results in an asymmetrical information distribution.^[4]

At this juncture protection devices are necessary, so that the capital seeker cannot damage the capital provider.

According to this the capital provider will use available means in order to monitor the agent (monitoring costs) while the agent is anxious to convince the principal of his loyalty (bonding costs). The principal will thus always be keen to negotiate an optimal form of contract.

The agency theory is in search of an optimal form of contract as well as an agreement on personal goals between principal and agent, and stands thus in contrast to the neoclassical financing theory, which acts on the assumption of a perfect market.^[5]

The so called agency costs resulting from managers misusing their position, as well as the costs for e.g. monitoring and disciplining them to try to prevent misuse. This issue is often described as the separation of ownership and control.^[6] In this cohesion the principals are the shareholders and the agents are the managers.^[7]

[...]

^[1] Cf. Meffert (2000), p. 145.

^[2] Ibidem.

^[3] Cf. Achleitner (2002), p. 46; Perridon/Steiner (2003), pp.19, Werner (2000), pp. 42.

^[4] Cf. Heitzer (2000), p. 139; Keasey/Wright (1997), pp. 2; Valcárcel (2002), pp. 43.

^[5] Cf. Achleitner (2002), pp. 48; Güllmann (2000), pp. 35; Perridon/Steiner (2003), pp. 19; Werner (2000), pp. 42.

^[6] Ibidem.

^[7] Cf. Schmidt (2001), pp. 20