Modern business requires sophisticated, flexible and agile financing. Many traditional banks have become so overwhelmed with non-performing mortgages that they cannot meet the needs of small and mid-sized firms. Traditional banking sector problems have lead to the need for alternative financing plans, such as mezzanine finance. Businesses now have a more flexible way to raise capital: a mezzanine loan.
What is Mezzanine Financing?
Investopia has the following definition for mezzanine funding: “A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies.” Mezzanine loans are basically debt capital that give the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full…”
Mezzanine loans are beneficial because they are treated as equity on a business’ balance sheet and could result in a better chance of getting approved for a conventional bank loan. To attract mezzanine capital, a business usually must demonstrate an impressive track record with an established reputation and product/service, a history of profitability and a viable expansion plan.
Who Are Mezzanine Finance Providers/Investors?
In many cases, mezzanine financiers are wealthy individuals who have chosen to invest in high-growth businesses. They create a pool of wealth used by mezzanine finance providers for business projects that fit a certain criteria. The mezzanine lender has a greater degree of latitude than a closely-regulated bank and seeks a closer partnership with the businesses they fund.
Mezzanine Loans Agreement
Mezzanine lenders will provide capital in return for a variety of financing agreements, including the following: cash interest, payable-in-kind (PIK) interest, ownership or participation payout. Lenders trade available money for business interests. Businesses raise money that might not be applied to normal loan leverage or coverage ratios.
Understanding The Mezzanine Capital Round
Stage financing involves the raising of different types and amounts of money over a period of time (round). The mezzanine round of financing is usually positioned between the venture capitalist and Initial Public Offering (IPO) rounds. Some companies might use the round of mezzanine lending to prepare for an IPO within the next 12 months. Each financier can determine his or her risk based on previous levels of debt and equity financing. Early investors owning junior mezzanine debt can be repaid with common stock.
How a Mezzanine Fund Works
A wealthy investor will add his money to a pool called a mezzanine fund. Similar to hedge investment funds, mezzanine funds have managers that might search for businesses with certain criteria, like positive cash flow. The mezzanine funds establish a financial relationship with a company on behalf of their limited partners.
Mezzanine Funding Rates & Term Sheets
The mezzanine financing term sheet will list the conditions and definitions of the debt contract. Terms could include the borrower, purchaser, expiration, purchase price, amortization and financing rates. Each meaning is clearly defined. For example, “What is the definition of documentation?” This detailed form also lists the governing law for the contract.
Mezzanine Investment as an Agile Alternative Financial Method
What are the primary benefits of mezzanine investment? Loan variety is one way that mezzanine debt is superior. A variety of funding mechanisms allows for a business to handle any adversity by “not placing all of your eggs in one basket.” Mezzanine debt is an alternative method that can complement or replace other loan plans.
Advantage of Working with Mezzanine Lenders & Financing Companies
What is a key advantage of working with mezzanine financiers? Independence allows for alternative finance companies to create customized mezzanine finance structures for each firm. Many banks are simply rewarming yesterday’s leftovers. These traditional banks follow a “one-size-fits-all” mentality. However, mezzanine financing companies can create a loan package that will better fit your business needs, circumstances and history.
Mezzanine Financing Examples
Mezzanine deals will combine debt & equity in exchange for funding. Here are two examples of a typical mezzanine loan agreement:
+ $70,000,000 of senior subordinated notes with warrants (8% cash interest, 2% PIK interests and warrants for 2% of fully diluted ownership)
+ $40,000,000 of redeemable preferred stock with warrants (1% cash interest, 10% PIK interest and warrants for 8% of fully diluted ownership)
Each fund structure offers a variety of financing mechanisms. The loan rates are also more varied than traditional loans. Mezzanine investments enable companies to add another debt & equity tranche.
Mezzanine Property Finance Structure
The mezzanine is an architectural term referring to a floor level in between ground and the main level. Likewise, mezzanine capital partners provide a form of funding that is “in between” as well: as a partially debt-based and equity-based loan. As property developments are faced with tighter financing requirements, mezzanine forms of financing allow businesses to continue to receive money when traditional funding sources have been exhausted.
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