March 14, 2019

thomas reuters

Loan Connector

(NY) Freedom 3 Capital grows mezz platform with Kansas City office

Freedom 3 Capital (F3C), a New York-based private credit investment firm, has expanded its business with a second office in Kansas City and the addition of two investment professionals, the firm said.

Partner Brian Block and Principal Aaron Blazer, both based in Kansas City, bring the size of the team to 11. They join F3C’s existing partners Jason Block, Fred Buffone, Erik Glover and Dan Tamkin.

“Kansas City sits at a crossroads and truly was a trading stop. There are a lot of businesses there and a lot of capital, including many second and third generation family owned, non-sponsored businesses,” said Jason Block, a partner and the firm's chief investment officer, in an interview with LPC.

F3C’s core business is providing mezzanine capital to non-sponsored middle market companies. Kansas City provides close proximity to a wide swath of Midwestern-based businesses that remain family or entrepreneur owned, but are in need of capital investment for strategic acquisitions, expansion or to refinance existing capital structures.

“The market where Freedom 3 sits doesn’t see the same volatility as the sponsored credit market, but we are having more discussions around helping companies prepare for an economic cycle,” Buffone said in the interview. “Companies are more receptive today to having a capital availability plan in order to preserve cash for a downturn.”

The firm primarily invests in companies with an average size of US$30m in Ebitda across industries, including industrials, consumer, healthcare and software. The average investment size is US$40m.

F3C, which launched in 2013, is now investing out of its third fund. Fund III is sized at just under US$250m, including parallel vehicles. Each successive fund has been approximately 50% larger than the previous one, Block said.

“We attempt to create a bespoke capital structure to meet the business plan. The capital we provide could come in a variety of forms including of senior debt, second-lien, subordinated debt or preferred stock,” said Block.

MEZZANINE

Mezzanine capital refers to any subordinated debt or preferred equity instrument in a company’s capital structure senior only to its common shares.

The capital is typically priced in the low double digits and mostly pays a fixed-rate cash coupon with some payment-in-kind, meaning it pays interest or dividends to investors in the form of additional securities or equity instead of cash.

For borrowers, in the current rising rate environment, subordinated debt has become more cost competitive with floating rate second-lien debt. Libor, the base rate for floating-rate loans, is now north of 2.5%, and at the same time second–lien spreads have widened, making mezzanine less expensive relative to second lien than it has been previously.

With quarterly middle market second-lien yields rising to 11.89% in 4Q18 and mezzanine all-in yields declining to 12.14%, the mezzanine yield premium over middle market second-lien debt is at its lowest level since 2Q16, LPC data show.

Mezzanine capital providers also typically have a longer term investment horizon and tend to co-invest alongside owners in the company’s equity to enhance returns.

“We think and behave like mezzanine partners and long term investors. Overall, we are less focused on IRR and more focused on money multiples; we target earning 1.5x to 2x our money inclusive of equity upside,” said Block.

leela.parker@thomsonreuters.com; +1 646 223 6893; Reuters

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