Subordinated Debt

Computerworld - A year ago, Dennis Deegan, CEO of Warner Power LLC, and four other top managers at the Warner, N.H.-based transformer manufacturer came up with a plan.

Warner Power's parent company, WPI Group, had recently shifted into the handheld computer terminal market, so Deegan and his fellow managers thought the time was ripe to buy out the company and go independent.

But, Deegan explains, "we needed quite a bit of money to do the deal, and we couldn't get it all through senior lending sources," which would have required collateral.

"We wanted to retain as much of the ownership of the company within the five key individuals that were involved," says Deegan, so they didn't want to sell equity in the new firm.

So the group turned to subordinated debt, also known as mezzanine debt, a form of financing akin to a second mortgage on a house. With subordinated debt, lenders have less recourse if a firm goes bankrupt because the senior debt lenders are first in line when the assets are divided. As a result, interest rates are higher, and borrowers must pass an extensive credit check in order to secure such loans.

For a typical midsize company, 15% to 30% of a corporate buyout will be financed by subordinated debt, with primary financing in the form of senior debt backed by collateral, says Malon Wilkus, CEO of Bethesda, Md.-based Capital.com Inc., an online clearinghouse that matches subordinated debt borrowers with providers.

Unlike senior debt, which is a relatively safe investment, subordinated debt requires a close relationship between lender and borrower, according to Todd Eyler, an analyst at Cambridge, Mass.-based Forrester Research Inc.

As a result, this particular marketplace is very illiquid, he says. Each loan is unique, and lenders have to be extremely cautious about each deal.

Fast Financing

Traditionally, finding a subordinated debt lender could take several months, but Warner Power took a shortcut by logging on to the Internet.

"From the time we started looking to the time we got a deal was a matter of days," says Warner Power President Dick Longo. "It really worked. In fact, it worked so well that, right as we speak, we're going through another small acquisition, and it's working again."

Longo turned to Wilkus' Capital.com, which matched Warner Power with its new lender.

It still took a few months from the time the deal was signed to the day the check was in hand. But Capital.-com helped tackle the first half of the problem - the time it takes to find a lender.