When a company needs a substantial infusion of capital for a purchase or to make a deal, finding financing can sometimes be difficult. Mezzanine financing acts as a bridge between equity and subordinate debt that is available to well-established businesses. If you are considering exploring mezzanine financing, it may help to speak with a corporate finance attorney from the Priori network about its implications and your options.
Defining Mezzanine Financing
Mezzanine financing is a unique financing instrument companies can seek out that falls somewhere between debt and equity. Because of this middle ground, mezzanine financing can be a way for established companies to acquire capital without tangible collateral.
How It Works
Mezzanine financing is a hybrid of debt and equity. Mezzanine financing is structured as a loan, but it is backed by securities. If the loan is not paid on time or in full, the lender can convert the security into equity at a predetermined price per share. While there are many different ways to structure mezzanine financing, usually some of the debts is additionally paid back as equity.
Mezzanine financing is generally quite expensive -- with interests rates often greater than 20% -- and only available to established companies with strong cashflow and an established history of earnings and growth. This is because such loans are unsecured and would be subordinated in a bankruptcy scenario.
Basic Structure of a Mezzanine Financing Agreement
Mezzanine financing agreements are generally very flexible, with few standard or required terms.
Advantages of Mezzanine Financing
There are four main advantages for companies that use mezzanine financing:
Capital. The main benefit of mezzanine financing is that it is a source of needed capital for companies having difficulty securing a needed amount.
Control. In mezzanine financing, the owner rarely loses control or direction of the company. So long as the business remains profitable, mezzanine lenders rarely dictate operations.
Balance Sheet Equity. Mezzanine financing is treated like equity on a company’s balance sheet, which can make it easier to obtain standard bank financing later.
Lender Partnership. Mezzanine lenders tend to be long-term investors, which mean they view such agreements as partnerships and can often provide valuable strategic assistance.
Disadvantages of Mezzanine Financing
Still, mezzanine financing is not always an attractive option for companies. There are four major disadvantages for companies looking for mezzanine financing:
Cost. The interest rate on mezzanine financing is significantly higher than that on traditional debt arrangements.
Restrictions. Many mezzanine financing agreements include restrictive covenants. These can dictate anything from requirements that the company meet certain financial ratios to limitations on how the capital can be used.
Complexity. Mezzanine financing is flexible, but this makes such agreements incredibly complex. Mezzanine deals take months to arrange and every term must be individually agreed upon. There is no standard mezzanine agreement.
Availability. Mezzanine capital is only available to established companies. This is not a means of startup capital.
When is mezzanine financing commonly used?
Often, mezzanine financing is used when there is a financing shortfall or when a company that is cashflow positive decides to fund a large project. Common examples of business situations that may include mezzanine financing include expansions, acquisitions, recapitalizations, and buyouts. It’s important to note that mezzanine financing is rarely used alone, but rather is typically employed in tandem with traditional financing.