What is Mezzanine Financing?
Mezzanine financing is a form of capital invested into companies that often combines equity and debt financing. Mezzanine financing is usually used by companies that are not yet ready to accept traditional loan financing—either because their credit rating is too low or because they cannot meet the strict guidelines and timelines associated with debt financing.
Mezzanine financing is most commonly used to help mid-sized companies that need to finance growth projects. Essentially, mezzanine financing gives companies additional access to capital beyond traditional lenders, private investors, and debt financing.
Mezzanine financing is popular among private-equity investors, venture capitalists, and other alternative investors for its higher returns and greater control. Because mezzanine financing involves the exchange of a stake in the company, investors have the potential to gain from a positive change in the company’s performance and value.
How Does Mezzanine Financing Work?
Mezzanine financing is typically used to fund a business’s growth projects and expansion plans. Often, businesses seeking more traditional forms of financing can supplement their loan with mezzanine financing, which can provide them with more flexible repayment options and a longer loan period.
Mezzanine financing involves the use of both debt and equity, since it involves the exchange of not only capital but a stake in the business itself. A mezzanine investor will typically provide the business with capital and in return, will receive either a portion of the business’s profits and/or equity in the business.
Mezzanine financing can be offered in a variety of forms, including convertible notes, convertible debentures, subordinated debt, and payment-in-kind (PIK) loans. Each option provides a unique set of advantages and disadvantages and should be considered carefully before taking out a loan.
Advantages of Mezzanine Financing
Mezzanine financing has many advantages for businesses seeking to finance their growth projects. The most notable advantages include:
• Flexible repayment terms: Mezzanine financing typically comes with flexible repayment options and a longer loan term than traditional debt financing.
• Access to capital: Mezzanine financing provides access to additional capital, beyond what can be obtained through traditional lending sources.
• Potential of higher returns: Mezzanine financing provides investors with a potential for higher returns than other forms of capital.
• Equity: Mezzanine financing involves the exchange of a stake in the company, so investors have the potential to gain from a positive change in the company’s performance and value.
• Control: Mezzanine financiers typically gain a certain degree of control in the company, enabling them to make sure the company is managed effectively.
Disadvantages of Mezzanine Financing
Despite its many advantages, mezzanine financing does have its limitations. The most important drawbacks to consider include:
• High costs: Mezzanine financing is typically more expensive than traditional debt financing, due to the equity component of the financing.
• Risk: As with all investments, there is always a degree of risk associated with mezzanine financing. If the company’s performance takes a turn for the worse, investor returns could suffer.
• Loss of control: Companies that take on mezzanine financing may risk losing a degree of control to their investors, who may take a more active role in the company’s management.
Conclusion
Mezzanine financing can be a great option for mid-sized companies seeking additional financing to fund growth projects. With its flexible option two willing parties can come to a mutually beneficial agreement, allowing the company to access capital while providing investors with the potential for higher returns. Of course, as with all investments, there is a degree of risk associated with mezzanine financing, so businesses should take into account the associated risk before taking on additional debt.
