Last editedOct 20202 min read
Business loans come in all shapes and sizes, but some options, like mezzanine financing, are more complex. Explore mezzanine financing in greater detail, right here.
Define mezzanine financing
Mezzanine financing is a blend of two kinds of business financing:
Debt finance: When a company takes on this sort of loan, it is indebted to the lender at an agreed rate of interest. This is the most common type of business loan.
Equity finance: This is when a company offers a portion of its business to secure finance.
Mezzanine financing combines aspects of debt finance and equity finance.
How does mezzanine financing work?
As a hybrid option, mezzanine financing is more complicated than the other two types of business funding, and for some businesses, may not be the most suitable option. That said, there are situations where there are more advantages to mezzanine financing than either of the more traditional options.
By opting for mezzanine financing, a company agrees to take out a loan, much like a traditional loan. However, the debt becomes an equity share after a certain period. If, by the time this deadline arrives, the company has not paid back the loan, the lender will receive a percentage of equity instead. While this may not be a sacrifice some companies are willing to make, for others, it can be a more flexible route to financing, especially if they have no other suitable collateral.
Who uses mezzanine financing?
Most commonly, small businesses that are well established but aiming to expand will choose this option. Lenders will also look for proof of growth and a robust financial plan to decide if future equity is sufficiently valuable enough. In addition, property developers will commonly apply for this mezzanine financing, as the investment property the loan is intended for will ultimately be the collateral. However, they may be turned down if they don’t have a strong track record of success and growth.
Why use mezzanine financing?
Mezzanine financing is most often used when a company has been denied a traditional loan due to the perceived risk being too high. It’s also possible to secure larger amounts of investment capital. However, mezzanine financing providers still fall behind senior debt holders in the pecking order when reclaiming their funds from a failed business.
Advantages of mezzanine financing
There are several advantages of mezzanine financing, including:
Larger amounts
Can be used to top up a standard loan, helping to secure further funding
It may be possible to defer interest payment
Sometimes, interest payments may be tax-deductible
After growth, you may be able to convert your mezzanine financing loan into a standard senior debt with a lower rate of interest
Of course, the disadvantages of mezzanine financing should also be considered:
Failing to pay results in loss of equity
Loss of control is common, as lenders can have strict criteria for how the business operates
Financial control may need to be sacrificed, i.e., paying dividends
Lengthy application process
Mezzanine financing interest rates
Like any business loan, mezzanine financing comes with interest rates. These are usually in the 10-30% range. These higher rates are due to the relative lack of security experienced by the lender, so a personal guarantee or another form of collateral may be needed to secure funding. As such, mezzanine financing can take weeks, if not months, longer than a standard loan to be finalised.
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