6.7 Enabling factors
308. Mezzanine finance takes place in private capital markets, whose development is thus essential for
the diffusion of hybrid instruments. Private capital markets are characterised by fewer formal disclosure
requirements and a smaller degree of official regulation and formalised investor protection than the public
markets, which are open to the general investing public (institutional and retail investors). In most cases,
private markets are restricted to professional, institutional or sophisticated investors.
309. The traditional market for commercial mezzanine finance has been upper-tier SMEs, with high
credit ratings and demand for funds above EUR 2 million. Securitisation and standardisation of mezzanine
instruments are used to facilitate the downsizing of mezzanine finance and access by lower-tier SMEs.
Securitisation can contribute to a greater availability of hybrid instruments as banks are able to sell their
risk exposures to the financial markets thereby regaining liquidity and the potential to lend more to the
SME sector overall (EC, 2007b).
310. Standardisation of mezzanine instruments can reduce the costs of provision and increase
transparency and accessibility by SMEs, which may lack knowledge and understanding about hybrid
techniques. In fact, the use of mezzanine finance instruments requires a certain level of financial skills on
the side of entrepreneurs and SME managers, who often lack awareness and capabilities to understand and
access a wider range of financial options than traditional debt. Public programs that aim at increasing
access to mezzanine capital by lower-tier SMEs often combine the financing with advice and mentoring.
6.8 Trends
311. In OECD countries, a well-developed commercial market in mezzanine finance has functioned
for more than two decades with minimal public involvement. In the 1980s the market was dominated by
insurance companies and savings and loan associations. Nowadays investors also include high net worth
individuals, family offices, pension funds, hedge funds, and banks with specialised mezzanine subsidiaries
(Silbernagel and Vaitkunas, 2010).
312. Despite the growing importance of mezzanine finance for financial institutions and SMEs, the
evidence about the volume of the overall market for commercial mezzanine finance is still patchy. The
main reason is that definitions of mezzanine finance differ across countries. Furthermore, not all
mezzanine finance is registered, as in the case of silent participation (EC, 2007b).
313. In most countries, the 2008-09 global financial crisis hit this market segment significantly. In
Europe, mezzanine investments, which had grown steadily over 2004-06 (Figure 11),
sharply contracted as
the crisis burst. The use of mezzanine finance has followed divergent patterns in the aftermath of the crisis.
The market contracted in commercial mezzanine finance, as did the demand for officially backed
mezzanine finance in many countries where the technique was well established. In other countries where
private lenders were in retreat, recourse to officially supported mezzanine credit appears to have grown as
governments stepped in to fill the void. However, throughout the recovery, as banks retreated from lending
to non-investment grade companies, debt financing targeting private capital markets has been increasing.
CEPRES, an industry research firm, estimates as much as USD 80 billion of new deal flow opportunity
worldwide between 2012 and 2015-1636.
314. Even as rates on traditional credits have tended to decline with the fall of interest rates since
2007, the coupon rate on mezzanine notes and expected returns of mezzanine investments have remained
relatively steady. This is consistent with long term trends in the market. In fact, unlike assets such as traded
equity, high-yield debt, and interest rates which exhibit volatility in the face of changing economic and
financial conditions, commercial mezzanine finance tends to have consistent and stable yields. (Silbernagel
and Vaitkunas, 2010).
315. On the qualitative side, it is possible to note relevant differences between the US and European
markets. In the US, with a more mature private capital market, mezzanine products come mainly as a
variation of publicly traded bonds, as it is the case for convertible debt and warrants. In Europe, where
bank lending plays a greater role in corporate financing, a private mezzanine market has been developing that is closer to debt financing, in the form, for instance, of subordinated and participating loans (Nijs,
2014).
316. In the European market, US-based and British GPs play a major role, particularly among largecap funds. On the other hand, small and mid-cap segments are led by French funds, followed by German,
UK,
Finnish and Italian funds (Figure 12). The capital to be deployed by funds, or “dry powder” (i.e.
marketable securities that are highly liquid and considered cash-like, allowing investors to purchase
assets), is however much larger in the large-cap segment (above EUR 500 million), than in the small and
mid-cap space. According to Idinvest (2014), in Europe, on average, small and mid-cap funds deploy EUR
0.4 billion per year, while mid to large-cap funds deploy EUR 2 billion. France remains the leading
European market for mezzanine debt with a total of 35 transactions in 2013 (the end of October), for a total
amount of EUR 1.6 billion, up from EUR 1 billion on 2012 (Figure 13). In the case of small and mid-cap
companies, mezzanine debt is largely used to finance organic growth and buy-outs.
6.9 Policies
317. In recent years, policy makers have sought to encourage the use of mezzanine finance, due to its
potential to provide finance efficiently to key categories of SMEs, and to extend it to SMEs with lower
credit ratings and smaller funding needs than the companies most commonly served by commercial
providers.
318. Public intervention can be classified into three categories:
1) Participation in the commercial mezzanine market, through the creation of investment funds that
target certain categories of SMEs and award mandates to private investment specialists. In many
OECD countries, governments have formed special investment funds that invest alongside
private investors in SMEs. Some of these funds may only invest in mezzanine vehicles, while
many have flexible investment mandates that permit them to invest in a broader range of assets.
There are two main ways in which public entities invest in SMEs through funds:
− a simple fund structure in which the public entity joins other public and private entities
and provides resources (equity, debt or mezzanine) to SMEs or
− a fund of funds structure, in which the public entity allocates funding to several funds that
provide financing to SMEs.
2) Direct funding to SMEs can be provided by a special agency, (e.g. an SME support agency or
development bank) under a specific programme. Typically, these programmes contain some mix of subordinated loans with a mechanism for participation in the sales, earnings or profits of the
company, when performance is good. Alternatively, the official agency may provide guarantees
while private institutions offer the facility.
3) Funding of private investment companies at highly attractive terms. This modality of government
support to mezzanine finance development is observed specifically in the United States. Under
the Small Business Investment Company (SBIC) mechanism, a government agency, the United
States Small Business Administration (SBA), issues debt and makes funding available to SBICs.
These are privately owned and managed investment companies that provide funding (in equity or
mezzanine form) to SMEs.
The SBA is a senior creditor of the SBIC and receives interest
regardless of the performance of the companies in the SBIC’s portfolio. The SBA does not
sponsor a fund that makes investment in SMEs, nor does it provide direct funding to any. Instead,
government support takes the form of funding at highly attractive terms.
319. All of these mechanisms require private funds to complement public funding, and all require
SMEs to pass various tests of financial viability in order to qualify for official support.
320. Unlike commercial mezzanine finance, which has tended to converge toward a uniform global
pattern, in the case of public participation, the specific pattern of mezzanine finance has tended to be
guided by the laws, institutions and policies of the jurisdiction in which it operates. These operations are
less standardised than fully private market operations and depend upon the decisions that each country has
made regarding the best way to structure its own programmes.
321. Nevertheless, most public mezzanine programmes avoid equity-like instruments such as
convertible debt or debt with warrants and instead favour silent partnerships or “success fees” under which
the agency receives a share of the profit or turnover of the company but does not acquire an active equity
stake in the company. In fact, these facilities generally entitle the agency to receive information about the
state of the company, but no right to take part in decisions of the company. This is the case of the
Development Contract (Contrat de Développement Participatif), introduced in France by OSEO (now
bpifrance) in 2009. The main component in the DC is a subordinated loan of seven-year maturity with twoyear grace (i.e. no principal repayments are made for the first two years). The interest rate may be fixed or
variable and is set according to the risk rating assigned by the Banque de France. OSEO receives additional
compensation in the form of a share (usually about 5%) of the increase in firm turnover following the loan,
and its risk is limited by a public guarantee fund, which covers 80% of the risk, plus a 5% deposit by the
company.
322. With regard to accepting equity-like positions,
the Business Development Bank of Canada
(BCD) would appear to be one exception among public financial institutions, as it is rather flexible in
structuring facilities to fit the situations of the target firms, aiming at a 15-17% target rate of return. A
typical BDC mezzanine facility contains a subordinated loan which provides a stipulated rate of return as
well as other facilities that provide additional income linked to the performance of the company, including:
a) royalties on sales or EBITDA37; b) interest based on enhanced value of the company; c) equity warrants;
or d) other factors that can be negotiated with the client.
323. An alternative model of public support is for an official agency to maintain a programme of
guarantees where actual funding comes from a private institution, such as a bank. This is the case of AWS’
Guarantees for Mezzanine Investments in Austria, which guarantees maximum 50% of mezzanine
investments in SMEs, up to EUR 7.5 million, provided it sustains projects related to the modernisation or
capacity expansion of a firm, plans to enhance R&D, or the acquisition of another company located in the country. At European level, the financial instruments of the Competitiveness and Innovation Framework
Programme (2007-2013) offered the possibility of mezzanine type financing through one of the windows
of its SME Guarantee Facility (the ‘Equity Guarantee Window’),
324. Another way for governments to support the development of mezzanine markets consist in
facilitating the participation of new investors, including smaller (i.e. retail) investors. In fact, there is only
limited possibility for these to invest in SMEs in any form, including mezzanine. This is the case of
specialised collective investment schemes (CIS), which receive the savings of smaller investors and
purchase assets that are traded in private markets. Some OECD countries have authorised the creation of
special investment vehicles in which retail investors can purchase shares of special CIS that invest in
SMEs through instruments such mezzanine finance, venture capital funds and unlisted equities. Indeed, in
some countries the authorities have decided to grant preferential tax treatment to these specialised CIS. For
example, in France a special investment vehicle, the Fonds Commun de Placement en Innovation (FCPI),
has been created to facilitate investment in companies that are certified as innovative under criteria
established by OSEO. Investment in FCPIs is tax deductible and capital gains on investment on FCPIs held
for a specified period are tax free.
325. Public suppliers of mezzanine financing include supra-national institutions. In 2009, the
European Investment Fund (EIF) launched a fund with a dedicated mezzanine mandate, the Mezzanine
Facility for Growth (MFG). This is a EUR 1 billion fund of funds mandate granted by the EIB to the EIF to
be invested in hybrid debt /equity funds throughout Europe, with a view to playing a catalytic role in this
market segment. The fund supports entrepreneurs who are endeavouring to keep control of their companies
as the company expands or address companies which need complex reorganisation of their capital
structures. Mezzanine also caters for later stage technology companies which have reached breakeven but
do not yet have access to standard funding (Kraemer-Eis et al., 2013).
326. As a case in point, the European Commission's CIP programme guarantees Boost’PME, the
participating loans programme of ISODEV, a French quasi-equity player that set up a securitisation fund to
finance micro enterprises. ISODEV managed to attract institutional investors by developing a very
selective approach to the risks linked to micro firms. The participating loans of EUR 15,000 to EUR
150,000 are provided as a top-up to bank loans. The guarantee agreement under the CIP is expected to
enable ISODEV speed up the deployment of this innovative offer, aimed at improving the financial
structure of SMEs and ease their access to credit.