A primer developed for general partners, limited partners, large and small companies and the general public with an interest in optimizing financial structures in Emerging Markets. The presentation makes the case for general partners to deploy further mezzanine-dedicated funds in developing economies.

1. THE CASE FOR
IMPACT MEZZANINE FINANCE
IN EMERGING MARKETS
PABLO E. VERRA
December 2019

2. A Typical Day in the Life of an Emerging Markets’ Investor
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© Pablo E. Verra – 2019

3. Executive Summary
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• Mezzanine is a great instrument to support companies that have a restrained access to the
financial markets and that want to optimize their capital structure;
• It is a hybrid instrument that can combine debt and equity and is highly flexible and
customizable;
• Generally, mezzanine is “underrated” and misperceived as “expensive debt”, particularly in
Emerging Markets;
• Mezzanine can be a great instrument to address the current funding gap that exists in
Emerging Markets, particularly for the “missing middle” companies and SMEs;
• The mezzanine industry in Emerging Markets remains small – dedicated mezzanine
represents, on average, 2% of total risk capital raised in developing economies;
• Mezzanine allows impact investors to achieve both developmental targets and financial
returns – the lack of correlation between profitability and impact is an unjustified myth;
• There is an appealing opportunity for existing general partners with a focus on
Emerging Markets to raise, deploy and successfully exit mezzanine-dedicated funds.
© Pablo E. Verra – 2019

4. ACompany’sBusinessCycle:DifferentFinancialInstruments
Phases in a Company’s Business Cycle & Traditionally Used Instruments
Source: Mezzanine Monitor.
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5. What is Mezzanine?
Risk
Return
• Mezzanine’s broadest definition is that it is anything that it is not “pure
senior, secured debt” or “straight equity”;
• Mezzanine combines elements of debt and equity;
• Mezzanine offers a wide variety of hybrid versions:
• It is, by nature, a flexible instrument;
• It is also highly customizable.
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© Pablo E. Verra – 2019

6. What is Mezzanine? (cont’d)
• Debt vs. equity-like mezzanine:
Features
DEBT-LIKE EQUITY-LIKE
Format • Straight high-yield / senior
unsecured debt.
• Sub-loans with PIK interest or
senior loans at a Hold Co level;
• Preferred equity.
Structuring • Defined interest / repayment
schedules;
• Covenants, default provisions;
• Security;
• Plus upside component (if
any).
• Low cash interest (if any);
• Limited security / covenants
(if any);
• Repayment from “liquidity
event” (rather than operating
cash-flows).
Primary
Source of Returns
• Interest repayments. • Equity upside.
• Mezzanine can be denominated in local or foreign currency;
• Upside through equity kickers is usually associated to local currency risk.
Source: Adapted from BroadBranchCapital.
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© Pablo E. Verra – 2019

7. Why Mezzanine?
• Mezzanineis agood mechanismtoattractadditionalcapital,whichaccommodatesmultipleneeds,restrictionsand
objectives
• Compared to senior debt
• More leverage for given cash flow and/or asset coverage;
• Cash-flow flexibility (PIK interest, grace periods / bullet maturities);
• Structural flexibility (OpCo / HoldCo);
• Balance sheet pruning (refinance, consolidation).
• Compared to equity
• Lower dilution;
• Lower cost.
• Mezzanineis aflexibleinstrumentthatcan offer attractiverisk vs.returncharacteristics
• Contractual yield;
• Built-in repayment / exit;
• Preferred position versus equity / other lower-ranked instruments;
• Access to remedies (covenants, default provisions, security);
• Currency risk passed onto borrowers
• For loan portion, equity kickers are normally exposed to FX risk.
• Mezzanineis a versatilebridgingtoolfor investors
• Equity exposure option for debt-oriented investors;
• Debt-like protections for equity-oriented investors;
• Ability to dial-in/out desired features to best meet any particular goal set.
• Goodtransitiontooltoeventuallyexpand into riskierequity operations. 6
© Pablo E. Verra – 2019

8. Mezzanine is Underrated!
The market generally perceives mezzanine as “expensive debt”.
Source: EMPEA;Preqin.
Total Mezzanine Raised in Emerging Markets – Per Region
Comparatively to private equity raised in Emerging Markets, mezzanine-dedicated funds represent a marginal portion of
total capital.
Emerging Markets Fund-raising ($bn)
2008 2009 2010 2011 2012 2013 2014 2015 Total Average
Private equity $ 63.00 $ 25.90 $ 46.00 $ 68.70 $ 52.50 $ 42.00 $ 69.20 $ 39.90 $ 407.20 $ 50.90
Mezzanine $ 1.06 $ 0.41 $ 0.70 $ 0.75 $ 0.70 $ 0.77 $ 0.46 $ 1.46 $ 6.29 $ 0.79
as % ofP.Eq 2% 2% 2% 1% 1% 2% 1% 4%2% 2%
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© Pablo E. Verra – 2019

9. The Funding Gap: An Accounting Perspective
The funding gap between senior debt and equity is common for the following reasons:
• accounts receivable, inventories and fixed assets are being discounted at greater rates than in the past
for fear that their values will not be realized in the future;
• many balance sheets now contain significant intangible assets;
• as a result of defaults and regulatory pressure, banks have placed ceilings on the amount of total debt
a company can obtain;
• while additional liquidity can be obtained from equity investors, equity is the most expensive
source of capital.
Source: Management Magazine, Bond Capital.
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© Pablo E. Verra – 2019

10. Addressing the Funding Gap with Flexible, Impact Capital
• As growth continues, mezzanine debt is a potentially attractive product for Emerging Markets as
companies address the capital demands of their business plans by taking much less dilutive
capital;
• The financial intermediation activity of banks in Emerging Markets has not coped up with
growth over the last 10 years (in Latin America it has remained practically stagnant; in Emerging
Asia and Europe, it has somewhat improved).
• Multilateral organizations have invested in mezzanine transactions, but, in general, have not done
so as part of their core strategy (e.g., ‘C’ loans);
• Fund managers, who have been active in the mezzanine finance in Emerging Markets, have usually
created follow-on vehicles to continue to meet funding demands;
• Mezzanine capital can offer a favorable risk-adjusted return profile, while giving protection
through covenants.
• Credit constrained firms in Emerging Markets are associated with lower productivity and low
employment growth;
• Mezzanine debt capital can be more flexible in how it is structured, providing needed capital and
enabling the instrument to match more closely companies’ needs and cash flow management
requirements.
Aligning
Interest and
Impact
Demand for
Mezzanine
Capital
Broadening
Financing
Offerings
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© Pablo E. Verra – 2019

11. WhyMezzanine Focused on Impact?
Investments that involve Environment, Social and Corporate Governance are here to stay –
mainly driven by relevant shifts in consumers, investors and employees towards a sustainable
future.
More investorsallocate
resources into
companies that look
beyond financial
results.
Ethical Investing =
Impact Investing
More consumers start to value which company is behindthe
products and services produced: up to recenttimes, they
chose only based on price, quality and convenience.
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© Pablo E. Verra – 2019

12. WhyMezzanine Focused on Impact?(cont’d)
Change in Generations: The Impact of Millennials
Driving the new investing trends:
• 75% of Millennialsare willing to pay more for
sustainable products.(1)
• 82% of high-net-worth millennials express an
interest in Socially Responsible investment
approaches.(2)
Source: U.S Truststudy.
(1)Morgan Stanley Institute for Sustainable Investing, Millennials Drive Growth in Sustainable Investing, August2017.
(2)Nielsen global study, The SustainabilityImperative, 0ctober 2015.
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13. Ending the Myth: Social Impact is a Profitable Business
GIIN Survey:
Impactinvestment
met expectations
for financial
performance
(76%)and therest
reported
outperformance.
(1)
48 investor exits
from impact
investments inIndia
(2010 –2015)
produced an US$-
IRR of 10%and the
top one-third
yielded a US$-IRRof
34%.
FTSE4Good UK index
avg. return of 60.31%
vs FTSE 100’s 50.85%
between2012-2017.
This index measures
the performance of
companies with
strong ESG practices.
(2)
US index KLD400,
the main ethical
benchmark, avg.
return of109.19%
vs 107.65%for the
S&P 500 between
2012-2017.
Investors
rewarded top
performers for
ESG topics(3) with
valuation
multiples3%-19%
higher than
median
performers.(4)
(1)GIIN Survey.
(2)Morgan Stanley.
(3)Industries:consumer goods,biopharmaceuticals,oil and gas,banking, and technology.
(4)Boston Consulting Group.
Firms that ignore environmental and social problems risk being damaged in the
future by large divestments from socially responsible investors.
WhyMezzanineFocusedonImpact?(cont’d)
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© Pablo E. Verra – 2019

14. Good Candidates for Mezzanine
In general, mezzanine is a great instrument to pitch to companies that have a restrained
access to the financial markets and want to optimize their capital structure:
• Private equity fund portfolio companies, with rapid growth, generally negative EBITDA and
operating in, potentially, non-traditional segments (e.g., tech);
• Companies with excess leverage (e.g., collateral maxed-out or faced with covenant limits);
• Companies with limited fixed assets to offer as collateral for senior debt (e.g., service
companies, knowledge-based firms);
• Shareholders who want to limit equity dilution;
• Jurisdictions where debt capital is scarce (e.g., frontier markets);
• Capital structure improvements (e.g., consolidation, re-terming, permanent working capital);
• Acquisitions financed at the holding company level.
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© Pablo E. Verra – 2019

15. Why Is Mezzanine Great for SMEs?
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• Ideal for firms that cannot go public: many SMEs are not far enough along in their development for an initial public
offering, operate in geographies without strong liquid public markets, or their owners do not want to relinquish firm
control. As long as the firm has a sound track record, stable cash flows or liquid assets, and an experienced
management team, mezzanine can provide the capital needed without giving up control or material ownership;
• Increases the firm’s credit rating: use of mezzanine finance in the capital structure of a firm can lead to eventual
increased access to traditional bank debt financing. Debt incurred through mezzanine facilities can be classified as
“subordinated debt”, considered largely equivalent to an increase in equity by banks and other traditional borrowers.
The more favorable ratio of equity to debt can lead to an improvement in the firm’s credit rating;
• Improves other loan terms and conditions: banks often look more favorably on companies that are backed by
institutional investors such as mezzanine lenders or private equity shops. This can lead them to extending more
credit under more attractive terms as a result of their reputation and their expected increased involvement with the
firm;
• Diversifies sources of financing: mezzanine lenders can help entrepreneurs to diversify their banking
relationships, thus acting as a source of reserve capital and reducing dependence on any one lender;
• Lowers financing costs: returns on mezzanine finance are higher than those on senior debt but lower than those on
equity. Mezzanine investors generally target a 15-25% internal rate of return compared to more than 25% for equity
investors. Therefore, mezzanine financing can lower SME financing costs with respect to equity;
• Allows for greater flexibility: while mezzanine debt is more expensive than bank debt, it is not as rigid. Generally,
mezzanine finance share similar arrangements as bank loans, but terms can be more flexible. For instance, providing
larger debt amounts, adapting amortization requirements to the SME’s needs, permitting a broader use of funds.
© Pablo E. Verra – 2019

16. Mezzanine Players in Emerging Markets
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As highlighted on previous slides, the mezzanine industry in Emerging Markets remains fairly small. The
competitive landscape to date has been comprised of:
• dedicated mezzanine specialists;
• private equity firms that have raised focused mezzanine funds;
• private equity firms that have made ad-hoc mezzanine investments through their private equity funds;
• banks and (less frequently) hedge funds that have provided mezzanine financing to select companies.
“One of the challenges we’ve faced as a firm doing
mezzanine is that the product is often misunderstood
by investee companies. The growth stage firms we
look at start out seeking either additional cheap
bank-like debt or minority equity. Many of these
companies learn eventually that they can’t get any
more debt and they can’t get minority equity as many
private equity investors insist on a controlling stake.
As such, a core part of our business and marketing
efforts is focused on educating prospective
borrowers.“ Darby.
“We try to be pragmatic and base our
approach on achieving the business
owner’s goals while providing the right
return for the level of risk we are taking.
In many cases, business owners are
seeking equity capital while they are
reluctant to offer a significant stake,
appropriate minority rights and/or
Board seats. They are in essence seeking
mezzanine but are not aware of the
product.” NBK Capital.
“There was a time when people
thought mezzanine returns were
not good enough and they would
only go for equity, but people have
become more realistic and changed
their views. When markets are hot,
people are often just focused on
returns and want to make a killing.
In difficult times, especially after
the crisis in the years between
2009 and 2011, investors are more
focused on protection of capital.
This has given mezzanine a
revival.” Mezzanine Management.
“Not all companies can issue debt in the local capital markets. Very often, they will have
obtained as much financing as they can from local banks., international banks and development
banks. We provide an additional source of capital.” Blue Like an Orange.
© Pablo E. Verra – 2019

17. Mezzanine Players in Emerging Markets (cont’d)
Latin America
A Short, Non-Comprehensive, Sample of Active Mezzanine Players in Developing Countries (1)
Asia Africa
(1) Does not include development finance institutions(DFIs)or NGOs. 16
© Pablo E. Verra – 2019

18. LET’S KEEP TALKING!
Pablo E.Verra
pablo_verra@hotmail.com