Mezzanine finance is a hybrid form of business funding, this article will detail what it is, how you can get this funding option, and the benefits of securing a cash injection such as this one.
What Is Mezzanine Finance?
Mezzanine financing sits between both debt and equity finance. When it comes to repayment, it ranks behind senior debt, where the debt has to be paid back if the company goes under, but before common equity, where investments are made by common shareholders.
It’s seen as a higher-risk form of debt than other loans on the market, but for that increased risk, there are higher returns available.
How Can I Get Mezzanine Finance?
How does mezzanine financing work? Mezzanine funding can benefit both the business owner and the provider of said capital. It often enables the borrower to borrow more than they typically would be able to.
It’s often required to help leveraged buyouts and acquisitions or help fund expansions and project developments.
How long does it take to obtain mezzanine financing?
When it comes to obtaining mezzanine funding, it’s more expensive to borrow it, but it usually carries a longer term until it matures. This could be up to seven or eight years. It’s typically provided as an interest-only loan.
Mezzanine finance lending criteria
With mezzanine finance lenders, the application will be assessed individually. However, the borrower often requires some similar lending criteria to qualify.
Planning permissions – It’s essential that relevant planning permissions have been secured and are in place. Some lenders may want this information as it can often be higher-risk than other lending purposes.
Industry experience – The experience you have is crucial as many lenders won’t go near those who don’t have a strong track record when it comes to borrowing money. However, everyone has to start somewhere, so some lenders will work with newcomers.
Funding in place – Where is the remaining capital coming from? Most lenders for mezzanine finance will want to understand where all the other capital is coming from to achieve your plans for the project.
Viability of investment – The viability of the investment will be based on all the criteria that the lender is after. From this, they’ll be able to decide whether you’re a good investment opportunity or not.
How Does a Mezzanine Loan Work?
How does it work? It’s best explained with an example:
The business is looking to finance £500,000 for their next project. They’ve managed to acquire a £350,000 loan from the bank and a further £100,000 from the company or the shareholders in investment. That leaves a £50,000 business finance gap that needs filling.
With mezzanine loans, the business can secure £50,000 and ranks behind the debt that the company owes to the bank. However, as it’s unsecured, it will warrant risk with premium interest payments, which often go up to 25%.
It’s a good way of helping to invest in your projects, utilise traditional avenues of borrowing such as loans from the bank, and get additional support from where you may fall short.
What Are the Risks Involved With Mezzanine Loans?
Naturally, with any loan, there will be risks involved, such as:
Higher costs could be a problem – Depending on how healthy your business finance is looking, you may find the higher costs of obtaining this financing too much. It’s good to add up the expected costs, so you’re not taking on too much.
Lack of control over your business – Some lenders are mainly hands-off, but you could have some that retain the right to have a substantial say over the company’s operations. This is particularly so if the loan isn’t repaid on time.
Difficult to make negotiations – When it comes to making merger deals and acquisitions, this can be more difficult with another party – the lender – involved in the process.
Is Mezzanine Financing Right for My Business?
For most, mezzanine financing is best suited for businesses with clear and often aggressive growth plans. For those who don’t fit these criteria, it is best to look at other options available. This might be other forms of funding or alternative business finance that are more suitable for your business.
Do I Qualify for Mezzanine Funding?
To qualify for mezzanine funding, the company must have a track record that’s credible within the industry, from regular and consistent profitability and a realistic plan for expansion through IPO or acquisition.
It’s also essential that you have a good cash flow available and that ideally, you have a good track record when it comes to money borrowed in the past.
What Are the Costs of Mezzanine Financing?
The costs of mezzanine finance would often include what’s called an arrangement fee, and this typically is around 1%-2% and an interest rate. These interest payments can vary vastly, whether that’s 1% per month or more.
You may also see an exit fee that typically is anywhere between 1%-2%. Costs of mezzanine financing are a lot more expensive than that of traditional loans, which is why some businesses may not go for this type of funding.
When is Mezzanine Finance Used?
Mezzanine capital can be used in a number of scenarios. These include:
- Financing new acquisitions.
- Buying out a business partner or current shareholder.
- Funding growth or new growth initiatives within the business.
- Generational transfers to help family members provide liquidity to current owners.
- Funding leveraged and management buyouts.
- Shareholder liquidity by financing dividend payments.
The Pros and Cons of Mezzanine Finance
What are the pros and cons of mezzanine debt? It’s worth researching this type of finance and whether it’s the right choice for your business or not.
Pros:
- They’re not collateral-focused – Thankfully, with mezzanine finance lenders, they’re usually lent based on the company’s cash flow rather than on collateral (assets). So as long as your business has enough cash flow, there should be no problems!
- Flexible capital – There are no immediate principal payments. These are usually interest-only payments with a balloon payment upon maturity. It means more working capital available for your business.
- Cheaper financing option than raising equity – Mezzanine finance is cheaper compared to raising equity finance amongst various investors and firms.
- Long-term financing option – Not all loans are appropriate as they often have a quick repayment term agreement. So, this long-term option can help when it comes to providing more capital for your business over time.
- Further control – The current owners of the business maintain control, rather than it being divided out to a variety of different parties. This can be helpful for any business wanting to increase its profits further.
Cons:
- More expensive – Bank debt is more affordable, whereas taking out mezzanine financing is a lot more expensive because it’s a riskier loan to take out.
- Warrants could be included – As a greater risk for lenders, they will often see to take part in the success of those they’re giving the money to, which might include warrants. These warrants allow them to increase their return if the borrower has performed well. Think of it as an extra added fee or bonus.
It’s worthwhile weighing up the pros and cons when it comes to mezzanine finance so that you know whether this is the best option for your business right now.
What Type of Collateral Will a Mezzanine Lender Require?
Mezzanine debt is different to other lending options whereby there’s no collateral required in order to secure the funding. However, that does come with the blow that these loans are often underwritten to deliver higher interest rates than those of traditional mortgage loans.
It means as a business, there’s a reduced risk as you’re not putting any of your assets on the line, should you fail with the repayments. Having to give over any of your assets could compromise your business, which is what makes these loans a more desirable offer than others that ask for collateral.
How to Choose a Mezzanine Finance Provider
Choosing mezzanine lenders is different from having to pick a traditional loan lender. These providers are more interested in the long-term strategy you have for your business. With that being said, you want to pick a trustworthy individual or organisation. One that you can build a trusting relationship with is essential!
After all, you want a partner that understands and respects your business goals. Whilst there might be many mezzanine financing lenders out there, it’s good to know which ones will be the better match.
Applying for mezzanine financing is relatively quick and easy to do. All you’ll need is to fill in a short online application form with the lenders in particular, or you could go on a comparison site to help compare your options.
Once you’ve supplied all the relevant information, you’ll get clarity on which lenders are willing to provide you with the loan balance you require.
Who Provides Mezzanine Finance?
The provider of mezzanine finance is usually anyone from long-term investors to existing funders of your company’s capital. It’s a good idea to take a look at all of your options before you go choosing one that simply presents itself first.
Remember, the criteria that they provide is just as important as what you are presenting. It’s good that they will help continue to help your business grow rather than stop you from progressing in any way.
There’s lots of research that can be done on the internet by yourself to find providers of mezzanine finance. Otherwise, you may find it helpful to speak to a broker who will do all the legwork for you. That way, you can focus more on your business than having to secure the right business funding.
Final Thoughts
Mezzanine financing is another opportunity to grow your business, especially for those who want to grow it quickly and at a scale. If your company matches the criteria that are typical for this type of business finance, it’s worthwhile exploring this funding option.
FAQs
Before taking out mezzanine finance, it’s worth knowing every detail for the sake of your business. Here are some frequently asked questions to fill in any of those gaps in your knowledge!
What is warrantless mezzanine finance?
Warrantless mezzanine finance would typically mean that lenders would require a performance-related reward that allows lenders the right to shares at the time of a sale or IPO. However, that’s now only common in mid-market and smaller deals.
Why is it called mezzanine financing?
It’s called mezzanine finance because the risk falls midway between secured loans and venture capital. The secured loans come from lenders like a bank, whereas the venture capital comes from equity financing through investors who have a stake in the company.
What is the difference between senior and mezzanine debt?
The difference between senior debt finance and mezzanine debt finance is that senior debt finance is a loan that comes from the bank. Mezzanine debt is a hybrid involving part loan and part investment. Senior debt is reliant on the lenders like banks to help out.
How does mezzanine finance differ from bridging finance?
Mezzanine finance differs from bridging finance because it will not directly hinder the business’ assets. For bridging finance, it allows those who use them to cross a financial obstacle in order to progress to the next stage of the project, paying it back once they’ve passed that point.