Hybrid Capital

Convertible Notes. A debt instrument that can be converted into equity at the option of the holder. The cost of borrowing is lower for the seller because the full value of the note can be converted into equity. However, The benefit of reduced interest rates must be weighed against equity dilution.

Mezzanine Financing. Mezzanine lending is a cross between debt and equity financing. It is typically a high cost and risky method of financing because the invested funds are normally not secured and are always subordinated to senior secured debt and others such as asset-based lenders and venture capital firms. However, mezzanine lenders can convert all or part of the debt to preferred shares of the company’s stock at a price agreed upon ahead of time, through warrants. So while the financing is initially structured as a debt vehicle its conversion rights to equity provides advantages over typical unsecured debt financing, such as subordinated notes. This is due largely because the converted debt is now treated like equity on a borrower’s balance sheet thus making the company more attractive to traditional bank financing, if refinancing of the senior secured debt is needed. Since mezzanine financing is normally employed in pursuit of business expansions or acquisitions, borrowers usually must have demonstrated a track record of steady growth and profitability. Therefore the conversion from debt to equity has now given the mezzanine lender an ownership interest in the successful growth and continued profitability of the borrower. In which they are now committed.

NWX structures mezzanine financing with lenders to support our client’s growth, acquisition or real estate objectives. Because of the firm’s ability to engage in both restructuring and mergers and acquisitions, we can negotiate lower finance terms, provide more operational security regarding the due diligence of the borrower, and create the financing more appealing thus being more competitive among lenders. The firm is also uniquely positioned in its client services to provide distressed clients with mezzanine financing. These insights from all perspectives assist NWX in arranging the most appropriate mezzanine structure for corporate development objectives as well as turnaround activities.

Exchange Notes. An unsecured and unsubordinated debt instrument whose returns are based upon the performance of a market index. No period payments are distributed and no principal protections exist. Though linked to the market they are not equities.

Owner Financing. A loan provided by the seller of a business to the buyer, unless there are other senior debt obligations. If so they would have to eventually be assumed or refinanced by the buyer. A down payment is normally required for the option of becoming a junior equity partner and installment payments are made until the debt is paid in full or until a balloon payment is made. The company is generally used as collateral by the buyer. Though rarely used as the only financing vehicle for mid-size companies, this vehicle is an option for smaller businesses that may find difficulty in finding a buyer in the first place. NWX and CSC Capital has negotiated several of these transactions successfully over the years for both corporations and in commercial real estate.

Royalty or Growth Financing. This financing vehicle can be either structured as a debt or equity financing arrangement, or it can be structured as a hybrid. NWX prefers structuring the financing offered by royalty lending firms using the hybrid structure as it both rewards the lender’s investment for corporate growth though also contains an equity risk component that secures the best long term interest of the borrower. Royalty financing is simply a lender providing funds for a certain percentage of company’s future collected revenue coupled with the ability of the lender to convert a certain portion of the debt to preferred shares of the company at a price agreed ahead of time. Sometimes royalty financing lenders may be inflexible to adapt both the debt or equity provisions in the loan structure, but to NWX it is critically important to the borrower to structure this financing method incorporating the advantages of both debt and equity. There are several reasons.

First, it is important that a revenue cap is agreed upon between the parties, typically expressed as a reasonable multiple of the investment amount. Second, the percentage of collected revenue should not be punitive, as weighted against the costs of goods sold and overhead. Here it is important that a detailed analysis of prior financial statements are examined as to the maximum amount of “royalty” burden that can be tolerated. Third, we emphasis “collected” revenue. The last thing a borrower should worry about is paying out a percentage of revenues that are never collected. If the lender claims that uncollected revenues are not their problem, then they do not have the borrower’s best interest. Better then to find a factoring firm as they contend with only collectable receivables. Forth, the percentage of a company’s revenue should not be a fixed percentage but rather a decelerating percentage as sales volume increases. When a company’s revenues increase the variable expenses associated with those sales will also increase accordingly. Therefore, a fixed percentage of revenues will deplete gross margins, profitability and eventually cash flow at a faster rate than volumes can increase, thus resulting in a lowering of corporate value. These are the reasons why NWX prefers that part of the financing is applied to equity. It keeps both parties interest aligned for mutual benefit.