What is Mezzanine Finance and how is it used?
Mezzanine Finance is a hybrid of debt and equity finance. While it can be a complex area of funding, it is a great way for businesses to raise more money than what they would be able from traditional sources such as a business loan.
Businesses typically opt for mezzanine debt solutions when looking to borrow money to finance their plans. Whilst they are simpler to arrange, they might not provide the amount of funding a business needs for their projects.
Businesses sometimes use equity funding instead, as it can provide larger amounts of funding needed for major growth. However, it does mean that you are selling a share in your business and will have to share all future profits with investors. This is the reason most businesses look for an alternative option as they don’t want to give up shares in their business.
A Mezzanine loan is the best of both worlds, it is used as a top-up, giving businesses that extra bit of working capital they need.
Features of Mezzanine Finance
The word mezzanine derives from the Latin word medianus meaning middle.
Mezzanine finance falls between debt and equity finance. The money is borrowed from the lender similar to debt finance. The equity is then used as security which gives lenders the ability to fund higher amounts of finance.
Mezzanine finance is more cost effective than using just equity finance. It also reduces the amount of equity businesses need to put in.
However, because of the complex nature and the fact that Mezzanine lending is a subordinated debt, the interest rates that businesses pay are higher. Unlike with other loans you don’t pay interest through out the term of the debt but instead pay everything at the end of the term. It is done this way so that companies can improve their cashflow, by investing the rewards of the loan back into the business and the growth plans.
Benefits of Mezzanine Finance
- Perfect for businesses with major growth plans
- A way to raise more working capital
- Great for cashflow as payments are made at annual intervals rather than monthly payments
- Businesses can achieve maximum return with minimum cash contributions
Who is eligible?
Mezzanine Funding is best used for those considering an acquisition, management buy-out or a large new project. It’s also great for property developers to strengthen their cashflow and to reduce deposits on their projects.
Lenders will typically lend to businesses who have a well-established reputation in their industry as well as being able to show a history of profitability and a viable plan for expansion.
What should you consider?
Before going ahead with a Mezzanine loan there are couple of things that you should consider. While this facility is one of the highest risks of funding it also gives out higher rewards.
It’s also important to remember that the equity in the business is used as security, meaning if a business can’t pay back the money borrowed the lender will be able to take shares of equity instead.
Due to the complex nature of Mezzanine debt, setting up the facility could take a couple of months to sort out. This is important to remember especially if you need the money in a short amount of time as you will have to look for alternative forms of funding.
What fees are involved
Rates for Mezzanine finance vary depending on which lender is used, as well as being priced on a per projected basis.
For those wanting to know more about the fees involved, speaking with a broker will help you best determine what you are looking at.
Examples of how it’s used
One example of mezzanine finance is for those looking to buy a business as part as a management buyout:
Say you want to buy a business; you’ve been to a lender and they have given you 75% of the amount you need but you’re still 25% short. Using a Mezzanine loan could get you a further 15%, leaving you just 10% to put in.
Alternatives to Mezzanine finance
There are many different alternatives to complex finance options, but we would always advice speaking to a broker. A broker will be able to sit down with you to discuss your business and the different options available to you, whether this be debt finance, equity funding or a Mezzanine loan.