Mezzanine Finance for Commercial Growth & Projects

Everything You Need To Know:

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• What is mezzanine finance?
• What is debt and equity vs. mezzanine?
• How can I get mezzanine finance?
• What are the benefits of mezzanine financing?
• What are the costs of mezzanine debt?
• Frequently Asked Questions

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

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.

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 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 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.

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