What is mezzanine finance?
Mezzanine finance falls in the middle of two main forms of funding, debt and equity. It is
typically used to support specific projects for growth and acquisition. A blend of debt and
equity financing, mezzanine is one of the highest-risk forms of borrowing, but offers some
of the greatest returns to businesses.
- Used to help acquisition and buyouts, finance large ventures
- High risk with high yields
- Interest rates between 12% – 20% pa.
How do you structure a mezzanine loan?
Mezzanine financing has a variety of structures which will depend upon the objective of the transaction.
Most commonly, a mezzanine loan is characterised by debt that turns into an equity share if the borrowing
company can’t pay back the funding. In the event of non-payment, the lender gets a share of ‘equity’, which is essentially security for the loan.
- Senior debt
- Mezzanine debt
- Preferred equity
- Common equity
What is debt and equity vs. mezzanine?
Debt describes the process of borrowing money whereas equity refers to selling shares in
the business in return for finance. Mezzanine finance falls in the middle of the two,
combining features of debt finance with risks and rewards of equity finance.
As mentioned previously, debt finance is a term used to describe the majority of business borrowing. There are several forms of debt finance, including secured and unsecured business loans, commercial mortgages and invoice finance to name a few. Whilst the terms of each funding type vary, the main principle of debt finance is that the business is taking on debt that will need to be paid back with interest over a pre-agreed repayment period.
Equity finance, on the other hand, describes the process of stakeholders investing in a business in return for shares. With this type of funding, you must be prepared to give up shares and partial ownership of your business, and the investors will benefit from the growth of the business, as well as suffering any business losses too.
Mezzanine finance is used to complement other types of funding. It is commonly used as a ‘top-up’ loan after the majority of investment has been agreed upon. With mezzanine finance, there is a hierarchy of debt so the mezzanine aspect of the loan only gets repaid once the original ‘senior’ debt repayments have been made. In the event that your business struggles to make repayments, the mezzanine lender has share options in your business as the debt gets converted to equity.
What is senior debt?
Issued by senior lenders, senior debt is essentially borrowed money that a business is obliged to repay first. Also referred to as ‘senior loans’, this debt takes priority over unsecured, ‘junior loans’ / debts that are also owed. As the highest priority, it is associated with more competitive interest rates because it carries lower risk.
What is mezzanine capital?
In the capital structure of a business, mezzanine capital occupies the gap between senior debt and equity.
How can I get mezzanine finance?
If you think mezzanine funding fits your business’ requirements, there are several
independent mezzanine lenders you can approach to discuss your situation. At SME Loans
we are experienced in delivering mezzanine debt amongst other funding options, so you’re
in safe hands.
Don’t worry if a mezzanine loan isn’t what you need, there are lots of alternative solutions
for funding business ventures. Get in touch and our team will help you find the best fit for
Am I eligible for mezzanine funding?
Mezzanine finance applications are approved on a case by case basis, and requirements vary from lender to lender. When deciding whether or not to grant funding and at which rates, the following will be considered:
- Industry experience and track record
- Number of years trading
- First charge funding plans and evidence
- Granted planning permission
What are the benefits of mezzanine financing?
Mezzanine finance is a high level funding solution that suits business’ expansion plans, commercial real estate acquisitions, leveraged buyouts and large scale development projects. It has several advantages, including:
- Retain ownership: The loans are structured to ensure you keep control of all strategic decisions. So long as the company manages debt repayments, you will keep the shares in your business.
- Flexible arrangements: Repayment terms and structures can be tailored to meet your business’ requirements and accommodate specific cash flow needs.
- Finance big growth moves: In certain situations, mezzanine finance can make the difference in unlocking finance for larger projects and acquisitions.
- Increased options: You can raise more money than would otherwise be possible based on your business’ performance alone.
- No need to sell: Mezzanine finance offers an alternative solution to simply selling equity outright.
- Access large amounts: Mezzanine capital allows you to unlock a greater amount of money than a standard secured loan.
What about the disadvantages of mezzanine finance?
All funding products come with pitfalls. Potential higher gains often bring greater risk so it’s important to be aware of what could go wrong with this type of financing.
- Risk of ownership loss: If projections don’t work out as planned, you could risk losing partial ownership and shares of the business.
- Strict lending criteria: Requirements and eligibility criteria for mezzanine financing can be strict and restrictive in terms of security that can be provided.
- Higher cost: Mezzanine finance is far more expensive than traditional loans and senior debt arrangements.
- Slower form of funding: Mezzanine deals are known for their lengthy processes, it can take up to 6 months to be arranged and finalised.
What are the costs of mezzanine debt?
Because mezzanine finance is a high-risk form of funding, interest rates are far higher than
with standard business loans. You can expect interest rates to be between 10 – 20%, and
sometimes even higher, due to the significant level of risk for investors. The good news is,
interest payment structures are flexible and you can usually choose whether you want this to
be monthly, quarterly or annually.
What is mezzanine debt?
Mezzanine debt is commonly used to fund leveraged buyouts and corporate acquisitions. Purchasing a business that is already established is always going to be expensive. Many entrepreneurs don’t have the funds readily available for this type of expense so it’s not unusual for a business to be purchased using borrowed money, through a leveraged buyout.
Leveraged Buyout (LBO)
Leveraged buyouts are typically executed by private equity groups. The business gets acquired predominantly through borrowed funds from banks and mezzanine financing providers, and the assets from both the acquiring business and company being acquired are put up as collateral for the loans.
A common situation is when a business owner chooses to end their ownership, and finds interested buyers from private equity firms. This buyout describes the transaction where the buyer borrows a chunk of funds required to purchase an asset (for example, the business) from the seller.
Frequently Asked Questions
If you want to learn more about what a mezzanine finance is, then make sure to checkout
our FAQs below for more information.
Mezzanine finance is a combination of debt and equity borrowing. A lender will lend money to a business, but should that business not be able to repay the lender, the lender will own a share of that company via ‘equity’. Equity becomes the security for the lender
You can get mezzanine finance by going to an alternative lender or by contacting a broker. The criteria for mezzanine finance differs from lender to lender. Generally lenders will look at how your business is performing and its history, such as the number of years it’s been trading for and monthly turnover.