Market analyst and practitioner Kevin McKenna (McKenna Gale Capital - see below) has written extensively on the character and history of mezzanine financing, emphasizing its evolving performance in assorted event transactions, including expansions, mergers and acquisitions. This evolution has not been challenge-free, however. A series of regulatory reforms in the 1980s, combined with effects of the recession at the end of that decade, notes McKenna, placed severe restrictions on the commercial lending practices of banks. One result was a reduction in what had been significant bank supply of subordinated (and senior) debt over the course of the 1990s.Endnote 62
Today, middle market clients must turn to specialized mezzanine pools (see below), merchant banks or pension funds and other institutional investors to pursue this option. This said, it is likely that total supply of pure subordinated debt is inadequate relative to demand in Canada, as compared to the United States (see Figure 9). Market practitioners interviewed by the CLMPC believe this reflects a major capital gap of relevance to SMEs.Endnote 63
One of the most important middle market developments of the 1990s is the new liquidity gained by an increasing influx of non-venture equity. Indeed, along with mezzanine financing, equity is establishing a much higher profile and utility in all event transactions, particularly those that reflect large sums, illiquidity and above average risk.Endnote 64 This trend parallels that of American private capital markets over the past two decades.
As was discussed in Pension Funds and Venture Investing, while the investment activity of venture and non-venture forms of private equity overlaps, to some extent, their respective markets are fairly distinct. Once invested, the two perform similarly, though according to very different client needs. Recently, Macdonald & Associates has begun collecting data on non-venture disbursements, defined as above $7 million, made by a growing array of merchant banking and private placement arms of corporate and financial sponsors, including pension funds.
Capturing a substantial fraction of the 1997 non-venture equity universe, Macdonald & Associates reported fifty- four deals done at a total value of $2.5 billion.Endnote 65 This private placement activity, rooted in either equity or subordinated debt, featured deal sizes in the range of $7.5-250 million, much of which was syndicated by the merchant bank subsidiaries of banks and pension funds (e.g., Ontario Teachers PPB) and limited partnerships of the type discussed below. Investee firms, such as Anchor Lamina (Windsor, Ontario), Groupe Benoit Allard (Chicoutimi, Quebec), Tree Island Industries (Vancouver, British Columbia) and ZCL Composites (Edmonton, Alberta) are situated primarily in manufacturing and service industries.Endnote 66
Canadian merchant banking was in a fledgling state in the 1980s and somewhat undifferentiated from other private capital markets, such as venture capital. All indications are that, beginning in the early 1990s, the middle market has gained considerable breadth and depth. Integral to its current supply, pension funds have also been influential in this structural development. Today, some of the biggest merchant banking operations are those of the Caisse de dépôt, OMERS and Ontario Teachers PPB, while HOOPP and the public sector pension plans associated with Alberta Treasury's IMD and British Columbia's OCIO are top suppliers to pools.
As private capital markets go, middle market investing is fairly conducive to pension asset exposure. Event- driven transactions draw on the pension fund's quality for patience. At the same time, risk-adjusted returns are possible at relatively low cost, achieved through a few deals of substantial dollar value and featuring traditional, demonstrably profitable business. Of course, these same factors may incline some pension funds to invest in the market's upper end and even larger private placements (e.g., above $50 million).Endnote 67