Cost & Value

The traditional way to measure the cost is to look at the weighted average cost of capital. The goal in many deals is to minimize the weighted average cost of capital which involves maximizing senior and mezzanine debt. Surely, ROI economics are more favorable with lower cost capital. However, the true cost of debt is not solely reflected in the interest rate. Too much debt results in a loss of operational flexibility and can significantly diminish a company's range of strategic options. Cost matters but the value of each layer is even more important. Mezzanine debt and equity cost more than senior debt but they are much more valuable than senior debt in a capital structure. A business can grow more rapidly, more safely with a higher degree of operational flexibility with mezzanine debt and equity. Assessing "Structure Value" is key to designing a structure. A breakdown of the cost and value of different layers is as follows:

For companies that need a longer term, and more flexible capital structure, mezzanine debt and equity layers are vital ingredients. For companies that require less flexibility, more senior debt can be used. The saying "you get what you pay for" is very much the case in designing an acquisition financing structure. While you pay more for mezzanine debt and equity, you certainly get more safety and stability and an overall higher structure value.