A second task is to design an investment strategy that deals with specific event-driven circumstances and goals. Some events may be satisfied by patient debt that improves on the terms of most conventional, collateralized loans. In other situations, what may be necessary is a multi-layer deal structure, reflecting a mix of financial instruments to effect the intended result. Depending on a project's risk orientation, impetus may be provided in a layer or layers of equity or quasi-equity. This often introduces what is referred to, in practitioner parlance, as the "kicker." Finally, some middle market investing may be handled with equity alone. All financing solutions must account for inherent strengths and weaknesses (e.g., debt load) of the existing internal capital structures of medium-sized and larger clients.
Naturally, strategic responses as singular as the event imply diversity in debt and equity combinations, time frames, and methods of oversight or, where necessary, more active, value-adding management. Diffuse events also spawn financial specialization. Some merchant banks may observe a general mandate for financing all "core" middle market events. Others may direct their whole attention to certain investment activity, as Schroders & Associates Canada does in relation to leveraged buyouts.
Again, depending on a transaction's inspiration as an event, the relative size of financing will vary in the Canadian middle market. Market analysts and practitioners indicate that, on average, deal size parameters are in the order of $5-50 million. Though comparatively rare, amounts invested can also be well in excess of $100 million.Endnote 60
What follows is an overview of the debt and equity tools of middle market event transactions: operating and term loans, mezzanine financing and non-venture equity.
The credit requirements of the majority of Canadian SMEs are quite modest, necessitating loans that are mostly short-term and involve sums of $50,000 or less. Middle market borrowing demand is of a different magnitude.
For instance, credit needs of medium-sized enterprises in the market can entail illiquid investing (e.g., up to five years or more). Hence, their objectives may be best facilitated by intermediate or long-term loans at fixed rates. These are often packaged in customized contracts sufficiently flexible to anticipate changes in the creditor's economic status over time. Such loans may also be only partially collateralized or unsecured. The trade-off for such terms and conditions are, of course, interest of above average rates.
The extent of this low visibility term lending is not fully documented in Canada. In the United States, the Federal Reserve System has shown private debt placements in the middle market (beginning at around $10 million) to rival, in volume of issues, both bank lending and the public corporate bond market. (see In Debt to Pension Funds).Endnote 61
Pre-eminent among lenders to the Canadian middle market are life insurance companies that offer, among other financing, long-term corporate debentures (unsecured debt) implemented using sophisticated risk control technologies. This function is well suited to them since, like pension funds, assets and liabilities must be balanced over long periods.
A potent debt-like instrument in the middle market is mezzanine financing. Also known as subordinated debt, such financing occupies a halfway point between debt and equity, strictly defined. It is called "subordinate" because it acts as one layer within an investee firm's multi-layer capital structure that comes after senior debt (i.e., term loans), but ahead of common equity. Its equity aspect frequently appears as the aforementioned "kicker" whereby the instrument is converted to, or otherwise shares in, the investee firm's ownership or earnings. In general, subordinated debt is linked to cash flow projections, is of longer duration (e.g., 5-10 years) than senior debt, and earns higher risk-adjusted returns.