Mezzanine funding can complement other forms of business financing.
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What is mezzanine finance?
Mezzanine finance is a hybrid type of business funding. It combines features of both debt (loans) and equity finance (selling shares). Due to its hybrid nature — it is a more complex form of funding. However, it can be an excellent way for a business to get the capital it needs.
Mezzanine finance — considerations
Business funding can be put into three simple categories. Debt funding — is where you borrow money at an agreed interest rate. Equity finance — is where you sell shares of your business for funds. Lastly, mezzanine finance — is a blend of the two.
Mezzanine finance is a great alternative source of cash, for companies involved in real estate development, acquisitions, buyouts — as well as businesses looking to grow rapidly. It is mainly reserved for funding high value projects — that can demonstrate excellent returns on investment. These potential returns, are what attract lenders, who seek to maximize their ROI — through debt or equity.
Mezzanine loans are mostly offered by alternative lending providers. These business loans are approved to enable either business growth or project development — in return for interest payments, a share of the profits and/or equity.
For companies than cannot raise enough financing through more traditional ways, mezzanine finance is a good solution — where It can “top up” or cover any shortfalls in project funding. For example, the main lender provides 70% of the capital you need, mezzanine finance may give you a further 20% — leaving your business to contribute just 10%.
Alternatively, you could use a mezzanine loan to simply raise more cash, allowing you to partake in bigger projects.
Mezzanine loan providers are usually willing to lend/invest to a business, as the loans they provide — may also give them equity. Equity investors are usually less risk averse than traditional lenders, and thus are more likely to fund riskier projects and ventures — that have plenty of upside potential. They are also more inherently vested in the success of your business/venture — over the long term.
As most mezzanine loans are not secured against assets — this presents a higher level of risk to the lender. Accordingly, as well as seeking equity guarantees, any interest charged tends to be higher than your standard secured or unsecured loan.
Where mezzanine debt acts as a top up or bridge (for an existing senior loan), the Mezzanine debt is subordinate (second charge) to the senior debt, i.e. the first charge loan. Thus, should a company liquidate — mezzanine finance lenders would be paid after senior debt holders (but before common shareholders).
How does mezzanine finance work?
Your business would need to seek an alternative lending provider, that deals with mezzanine debt products. You would supply them with details of your business/venture, and based on this information they may approve a mezzanine loan.
The mezzanine loan can be structured in a number of ways. In most cases business equity is offered, as security against the loan. Money will be lent with interest, and should your business be unable to repay — equity will be taken up.
Other mezzanine lenders will require a share of the profits, that result from your business venture, and should the loan be settled on time — the lender will not seek to own shares in your business. Further, with some deals — lenders seek to own equity as a condition of providing the loan.
Unlike traditional funding arrangements, which are paid back in regular installments, mezzanine finance is more flexible. Mezzanine funds may be arranged in a way, where your business repays annually or where small initial payments are made — followed by a large lump sum at term end. In this way, the financing is structured to enable your business to better manage cash flow.
Benefits of mezzanine finance
- Highly flexible financing solution — that is tailored to your needs
- Access to more capital than you would otherwise have
- Allows you to leverage finance — for bigger deals
Limitations of mezzanine finance
- Potentially have to give up equity in your business
- Complex arrangements — takes time to get the funds
- Higher interest rate payments
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