Mezzanine Capital in Europe

Mezzanine Capital in Europe

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Inhaltsangabe:Abstract: In corporate finance two major decisions have to be made. One is the investment decision which means companies must decide which available opportunities they should invest in. The other one, the financing decision, also known as the capital structure decision, tries to answer the question of from where the money to finance investment projects should come. Money can either be raised internally, through retained earnings, or externally. Mezzanine capital, as a special type of external finance, therefore falls into the area of the financing decision. Although the use of mezzanine capital has increased in Europe in recent years, this special type of finance is still relatively unknown in some countries. Therefore, the purpose of my thesis is to familiarise the reader with this particular type of finance. It is structured in a way that it sequentially deals with the following questions: How did mezzanine develop? Can it offer an advantage compared to financing only with debt and equity? Which basic types of mezzanine instruments exist and how are they valued? When and where is mezzanine used? At the end, an example of a management buy-out in which mezzanine is used is provided. This will give important insights into the practical use of multiples to structure the deal, the mezzanine investment process, the investment criteria and the various exit routes that exist. The paper will be concluded with an overview on the European mezzanine landscape and on how recent stock market developments and the new Basel capital accord (Basel II) may impact the future of mezzanine capital. Special terminology or important information that is used in the private equity area is written in bold letters if mentioned for the first time in the text. The issue of a convertible promissory note to raise funds to build a canal in the UK is believed to be the first mezzanine instrument. It was issued in 1798 by the Company of proprietors to the Canal Navigation from Manchester to or near Ashton-under-Lyne and Oldham . However, the idea of converting debt into equity was already used after the War of Spanish Succession when in 1711 the British government had a heavy debt burden. As the debt was trading at a substantial discount it made the refinancing more difficult. A solution was found in creating a new body, the South Sea Company , whose newly issued shares were to be swapped for Ap9.5m of floating debt - thereby reducing the interest payments by three percent per annum. In the 1980s a high rate of new product innovation, especially in financial markets, could be observed. Among the products innovated or revived during that decade were swaps, index options, mortgage bonds and mezzanine finance. The following reasons led to the particularly strong product development in the corporate finance market: Deregulation of the domestic financial markets in the major OECD countries. The lifting of controls over the flows of external capital movements in many countries. Liberalisation towards the internationalisation of securities markets and merger and acquisition (MaA) activity. Global monetary conditions with low interest rates and a revival of economic and corporate activity. The above stated reasons in turn led to increased competition and the establishment of large financial conglomerates which mainly used tailor-made financial services to differentiate their products from those of competitors and also to fulfil their clients desires. After the equity market crash in October 1987 the monetary banks of the largest economies, fearing a financial recession, reduced interest rates even further. Investments that appeared too expensive in risk-return profiles became profitable. The financial market reacted by placing more emphasis on the design of securities that resembled debt more than equity. But this also raised the price expectations of corporate sellers creating a gap between the total amount of a deal and the amount that could be financed with senior debt and equity. The amount of senior debt banks would provide is limited to the company s assets which are used as collateral and any additional injection of equity would further dilute the shareholders ownership structure. Table of Contents: 1.Introduction1 1.1Purpose and Structure of this Paper1 1.2History2 1.3Definition and Terms3 2.Capital Structure Decision5 2.1Capital Structure Decision in Perfect Markets6 2.1.1The Traditional View7 2.1.2The Modernist View8 2.2The Concept of Leverage8 2.2.1The Total Leverage9 2.2.2The Operating Leverage9 2.2.3The Financial Leverage10 Unlevered10 Levered10 2.2.4The Traditional View Revisited12 2.2.5The Modernist View Revisited13 Proposition I13 Proposition II16 2.3Capital Structure Decision in an Imperfect World20 2.3.1Corporate Taxes22 2.3.2Corporate and Personal Taxes27 2.3.3Costs of Financial Distress28 Bankruptcy Costs31 Bankruptcy Costs31 2.3.4Asymmetric Information32 2.3.5Agency Costs33 Costs of Debt33 Costs of Equity34 2.3.6Transaction Costs35 2.4Capital Structure and the Case for Convertibles36 3.Valuation of Mezzanine Instruments40 3.1Black-Scholes Option Pricing Model40 3.2Valuation of a Convertible Bond43 4.Summery on Capital Structure and the Valuation of Mezzanine Instruments49 5.Basic Types of Mezzanine50 5.1Mezzanine Prototypes51 5.1.1Fixed or Floating-Rate Loans51 5.1.2Unsecured Loan Stock52 5.1.3Convertible Unsecured Loan Stock52 5.1.4Redeemable Preference Shares53 5.1.5Convertible Preference Shares53 5.2Characteristics of Equity54 5.2.1Advantages and Disadvantages of Equity55 5.3Characteristics of Debt56 5.3.1Coupons or Interest Payments56 5.3.2Principal Repayment57 5.3.3Security59 Mezzanine - Debt Mezzanine Capital59 Mezzanine - Equity Mezzanine Capital59 5.3.4Liquidity60 5.3.5Advantages and Disadvantages of Debt60 6.Risk and Return of Mezzanine Instruments61 7.Use of Mezzanine62 7.1When is Mezzanine Used62 7.1.1Early Stages63 7.1.2Expansion Stages64 7.1.3Post-IPO Stage64 7.1.4Public-to-Private Stage64 7.2Providers of Risk Capital64 7.2.1Friends and Family65 7.2.2Business Angels65 7.2.3Incubators66 7.2.4Early Stage Venture Capitalist66 7.2.5Venture Capitalists66 7.2.6Private Equity66 7.2.7Mezzanine Investors66 7.2.8Investment Banks67 7.3Amount of Mezzanine Used67 7.4Creating Extra Value with Mezzanine Finance68 7.5Use in Different Corporate Strategies70 7.5.1Growth Finance70 and Technology Development71 7.5.2Corporate Restructuring and Acquisitions72, MBIs and LBOs72 Transition73 Consolidations73 7.5.3Refinancing74 Around or Bankruptcies74 8.Mezzanine Capital in Practice75 8.1Financial Structure75 8.1.1Senior Debt75 8.1.2Mezzanine Finance76 8.1.3Equity77 8.2A Successful MBO with Mezzanine Capital78 8.3The Mezzanine Investment Process81 8.3.1Business-Plan82 Information82 Information83 8.3.2Letter of Intent83 8.3.3Due Diligence and Investment Memorandum83 8.3.4Contract and Investment84 8.3.5Monitoring84 8.4Investment Criteria85 8.5The Investor's Exit85 8.5.1The Return86 8.5.2The Exit Route86 Public Offering87 Sale88 Purchase89 Off89 9.The European Mezzanine Landscape89 9.1The UK-Market90 9.2The Rest of Europe 93 10.Mezzanine in the Future97 11.Conclusions100 Literature102... a Modernista#39;s View on Leverage and Expected Return Source: Brealey, Myers, Principles of Corporate Finance, 2000, p. ... The answer to that puzzle is that any increase in expected return is exactly offset by an increase in risk and thereforeanbsp;...

Title:Mezzanine Capital in Europe
Author: Markus Herbert Tyl - 2002-11-21

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