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.
A lot of midsize firms never find the financing they need in time
to make the deal because it's so hard to track down the right
provider, says Wilkus.
"Wall Street is only geared toward the largest firms," he says.
"It's the last remaining inefficiency in the financial market."
Capital.com's parent company, American Capital Strategies, saw an
opportunity in that inefficiency and spun off the Internet firm to
link borrowers to providers of subordinated debt.
Subordinated debt is often used by companies looking to expand or
buy up a competitor, says Mark Opel, chief operating officer at
Capital.com.
"It allows you to raise additional financing that is less
expensive than equity and that doesn't have that dilution in
ownership," he says. "When you need more than what the bank will
lend you, it tends to be the most cost-effective source of financing
to fill that gap."
Some Skepticism
But traditional subordinated debt providers say they're skeptical
about the Internet-based model of financing for this market.
"I have my doubts," says Lee Haskin, CEO of New York-based Haskin
& Associates Inc., which placed $235 million in subordinated
debt this year.
"Senior debt is like the first mortgage," he says. "It's more
black and white. You look at the value of the property, see whether
the borrower can afford to service the debt. It's more simplistic.
With subordinated debt, it requires so much more relationship
involvement. The lender isn't really protected, so they have to look
at where the company is going."
Haskin says he's seen other players try to create a subordinated
debt marketplace on the Internet and fail because it's hard to
describe a deal adequately in a fill-in-the-blanks form on the Web.
An intermediary that knows the company, knows the company's
management and understands the industry is critical, Haskin says.
"It's so subjective," he says. "And a hands-on relationship is
important."
If Capital.com is able to develop relationships of trust and deep
communication with borrowers and lenders, then it might work, he
says.
"But how much information can you really get over the Internet?"
he says.
Sites 
