Firm’s Hunt for Capital Ends in the Mezzanine

Abdi Lajevardi emigrated from Iran to the United States 25 years ago because he believed in the American dream. Today, he runs a $23-million company on the fast track to bigger growth because he discovered that, for a small business, raising capital doesn’t mean taking what you can get from your friendly local banker. It means choosing from among many, many other options.

In Lajevardi’s case, it meant using a powerful but little-known technique called mezzanine financing to launch an expansion program for his company, United Education Institute Inc., headquartered in Irvine. The company trains people for jobs in the computer and health industries, and Lajevardi saw a chance for growth.

As outlined in this space last week, mezzanine financing allows the owner of a small business to:

* Raise anywhere from $500,000 to $20 million in capital from pension funds, insurance companies and banks in much the same way big businesses do.

* Keep control of company stock.

As a rule, mezzanine financing raises both debt and equity capital. In plain English, this means that you raise some of the money you need by borrowing it and some by selling an interest in your company to your lenders--usually not more than 20% of your stock.

Investment bankers do mezzanine deals with young (though not start-up) high-tech companies to propel them to fast growth. Mezzanine deals over $20 million are common. Few investment bankers do deals worth $5 million, however, and what Lajevardi wanted--only $2 million--doesn’t register on the radar screens of most investment bankers.

But in Randy Zurbach, founder of Pinecreek Capital, an Irvine-based small-business investment company, Lajevardi found an investment banker who specializes in doing sophisticated mezzanine financing for small businesses.

Like many owners of small businesses, Lajevardi didn’t know much about mezzanine financing, or indeed about any kind of business financing beyond conventional bank borrowing.

“I personally had very little understanding of capital financing before I met Randy,” Lajevardi says. “One of my colleagues had some understanding of it, but basically none of us had been introduced to the idea. But because Randy targets businesses of our size, his ideas reflected our strengths and weaknesses--so mezzanine financing was a good alternative for us.

“It’s a little more expensive than traditional borrowing through banks, but if you don’t have a lot of hard assets and you do have cash flow, it gives you access to capital that you otherwise can’t get.”

Like many other small-business owners, Lajevardi had found the hunt for capital frustrating--because he had gone only to his bankers in search of it.

“We already had a bank credit line for $1 million, but that wasn’t enough,” he says. “We had been looking for more capital for growth purposes for some time, but companies in our category--businesses with $15 million to $30 million in revenue--have a difficult time borrowing what they need from banks.”

Zurbach reduced the complexities of mezzanine financing to a one-page outline proposing:

* $2 million in debt payable over five years, with the first two years at 12% interest only.

* Warrants giving Pinecreek Capital the right to buy 12% of United Education Institute’s stock.

It was a debt-heavy deal--as are most mezzanine deals involving capital sums of less than $5 million. In other words, Lajevardi raised most of his capital by borrowing it, and although Pinecreek Capital holds the right to buy some of his stock, he can call, or buy back, the right to half of that interest at the end of two years.

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What’s more, the $2 million consisted entirely of subordinated debt--a technical term signifying that Pinecreek Capital holds a lesser claim on the assets of Lajevardi’s company than would a traditional bank lender holding a lien on receivables, inventory or equipment. Put another way, if Lajevardi goes belly up, any bank he owes money to has first dibs on his assets. Zurbach stands with other creditors to divide what’s left.

If Lajevardi’s deal sounds complicated, it isn’t. In fact, it surprised him how easily Zurbach put together the deal. Like many small-business owners, Lajevardi hadn’t realized that there is a great deal of capital looking for work, as it were, and that the difficult thing is not to raise it but to learn about its availability and the many forms it can take.

“We had a feeling that it would be more complex than it was,” Lajevardi says. “We presented Randy with our business plan and our financial statements and gave him some projections about what we thought we could do with our expansion plans.

“Once we agreed on the terms, it took about two and a half weeks of due diligence, and then we got funded.”

Lajevardi used the capital to open branches in Georgia and Florida to do what he does at six branches in Southern California--train computer networking and multimedia technology specialists, medical assistants, and dental and pharmacy technicians. He plans to open more branches in New York, Washington, D.C., and Chicago in an effort to become a major player in vocational training.

In all, Lajevardi says, the expansion should add 30% to his revenue.

“Mezzanine financing will work very well for us,” he says, “and I think it’s a good alternative for other business owners who find bank financing difficult to get or too expensive.

“We were in position to look at a lot of bank-financing alternatives, and we chose this path because it fit the need. In about three years, we will look at repaying the loan. We should have enough cash to take care of it out of our increased revenue.”

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