Mezzanine financing combines debt and equity financing (also known as the process of raising capital by selling shares in an enterprise business). Basically, in the event of default it enables lenders to become an owner in the business or gain equity shares, after venture capitalist or other senior lenders are paid out. This requires very little, or in some cases no collateral from the borrower and a few reasonable step taken by the lender in order to satisfy any legal requirements.
Understanding How Mezzanine Financing Works
For a company to attract this type of financing, you must be able to clearly show and provide sufficient proof of:
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Your industry track record
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An established reputation
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An established product or service
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Profit history
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An expansion plan for the business that is viable (acquisitions, expansions, IPOs)
Typically, interest rates for mezzanine financing range from 12 to 20 percent. This makes it it a high-risk, with potential high-debt. It serves to replace part of the venture capital limiting the need for equity investors to provide it to the company, allowing the the company that’s purchasing or acquiring it to contribute even less of its own capital while leveraging its return.
Advantages & Disadvantages of Mezzanine Financing
Like any other type of financing, Mezzanine financing also comes with its pros and cons.
Here are a few of the disadvantages of Mezzanine Financing:
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Lenders can gain equity in the business or company or gain authority to purchase equity later on, increasing the investor’s rate of return.
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Applicants are legally obligated to pay interest (monthly, quarterly or annually) to financing providers
Now let’s have a look at the advantages:
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Mezzanine debt is tax-deductible
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Mezzanine financing is easier to manage when compared to other debt structures because interest can be added to the loan balance
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Interest can be deferred if a borrower can’t make the scheduled interest payment, usually not available for other debt types
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It can be restructured in one senior loan with a lower interest rate if the company expands rapidly, saving thousands in interest costs
As you can see, there are definitely more advantages to Mezzanine financing than there are disadvantages. But it’s always wise to consider both.