Mezzanine Loans a Powerful but Overlooked Tool

If you find yourself frustrated by the search for capital to make your business grow, listen to the story of Ken Cohen, president and CEO of Synbiotics Corp. of San Diego.

This year Cohen tapped a little-known source of capital to finance the acquisition of a company not much smaller than his own. The deal added 60% to his revenue and made Synbiotics a two-continent powerhouse in veterinary vaccines and related animal health products.

What’s more, Cohen borrowed all the capital he needed for the deal using a technique called mezzanine financing--a powerful tool common in big-business capital financing but little-known among small-business owners. The technique is available to big and small companies alike, and it deserves attention as an effective path to fast growth.

Cohen’s experience shows that you can find capital if you know where to look and get good advice.

“I had never done debt financing,” he says. “I had to learn a whole new vocabulary and discover a lot of players I had never heard of before.

“I couldn’t believe there was so much capital available for mezzanine financing--banks and funds with hundreds of millions of dollars to invest, and I had never heard of them.”

Cohen knew nothing about this form of financing when he took the helm of Synbiotics 18 months ago, but he knew he wanted to grow the company fast. (The publicly traded firm had about $17 million in sales in 1996. Synbiotics closed at $3.31 on Nasdaq on Tuesday, giving the company a market valuation of $27 million.) Widely known among U.S. veterinarians, Synbiotics did meager business in Europe even though the Continent constitutes roughly a third of the global marketplace for products such as those made by Synbiotics.

Cohen needed the wherewithal to penetrate that market.

Enter Jeri Harman, senior vice president for corporate finance at Van Kasper & Co., a respected California investment banking house. Harman suggested that Cohen look into mezzanine financing, which, as outlined earlier in this space, allows a small business to borrow sums ranging from $1 million to $20 million from institutional lenders such as insurers, pension funds and bank holding companies.

Large businesses borrow from institutional lenders all the time. Small businesses don’t--not because they can’t, but because few business owners even know that this source of capital exists.

Most small-business mezzanine deals combine borrowing and equity financing; you raise the bulk of the capital you need by borrowing it and the rest by selling a minority interest in your company to your lenders. The combination allows your lender to profit two ways--by earning interest on the money you borrow and by realizing gains on the increase in the value of your stock as your company grows.

The package Cohen put together combined two $5-million term loans plus another $5 million in a revolving working-capital loan--$15 million in all--with warrants attached giving the lenders the right to buy 2% of Synbiotics stock. The deal called for Synbiotics to amortize one of the two $5-million term loans over five years and pay interest only on the other term loan for five years, followed by a balloon payment to retire the debt.

In July, Cohen used $12 million of this capital to buy a unit of the European pharmaceutical giant Rhone Merieux that specializes in veterinary diagnostics. The deal added about $12 million to Synbiotics’ annual revenue--a major acquisition.

“We bought something that represented maybe a couple of percentage points of Rhone Merieux’s total sales but that, to us, meant a 60% increase in our size,” Cohen says.

Why did he finance the acquisition with debt when he might have issued Synbiotics stock to raise capital?

“The name of the game in building value for your shareholders is to grow your assets faster than you issue stock shares to pay for them,” Cohen says. “If you double your size and double the number of shares outstanding at the same time, you haven’t got your shareholders ahead of the game.

“We asked ourselves, ‘How many new shares would we have to issue to pay for this, and by how much would we dilute existing shares?’ We concluded that raising the capital that way would give us very expensive money.”

Borrowing it in a mezzanine deal was far cheaper.

“We’ve only owned this European unit since July, but our third quarter showed strong sales growth and cash generated from operations up a lot over the previous year,” Cohen says. “That allowed us to make an operating profit in the quarter for the first time.”

Put another way, the deal leveled out the seasonal ups and downs of Synbiotics’ revenue, Cohen says. And it yielded cash flow strong enough to handle the debt created by the mezzanine financing.

“By now we’ve seen pretty good evidence showing how beneficial this acquisition was,” Cohen says. “And it has also done a lot for us strategically. Almost one-third of the market for products like ours is in Europe, and our sales there prior to this acquisition were almost immaterial.

“Now we’re getting almost a quarter of our business from Europe.”

What wisdom does Cohen have for other business owners frustrated by the search for expansion capital? Get good advice--and use somebody else’s money to grow your operation.

“Don’t hesitate to pay good money for quality advice,” Cohen says. “I’ve seen businesses fail because the owner was reluctant to pay the price for a good manager or a good lawyer--or a good investment banker.

“I also read the stories about the dedicated entrepreneur who mortgages the house to start a business, and I admire the courage. But I always wonder: If it’s such a good idea, why not persuade somebody else to finance it? It worked for us.”

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Freelance writer Juan Hovey can be reached at (805) 492-7909 or by e-mail at jhovey@compuserve.com