Published: Mar 06, 2020
Last month we helped to explain a lesser-known and often misunderstood funding option, mezzanine finance, in everyday terms. Mezzanine finance might not be your usual form of debt finance but in the right circumstances, it can prove a very useful means of helping your businesses achieve its growth plan.
Often described as a ‘hybrid’ of debt and equity funding, a mezzanine loan can be structured so that capital payments come with little to no equity dilution. Mezzanine finance can be a relatively cost-effective way vis-à-vis equity to fund growth strategies and traditionally ranks behind any senior (bank) debt, which is helpful from a bank’s perspective.
Demetri Theofanou, Investment Manager for Maven, considers when mezzanine finance is most appropriate and the benefits of securing this type of finance from a business owner’s perspective.
- When does it make sense to use Mezzanine financing?
Mezzanine financing can be used in situations where companies don't qualify for sufficient bank debt, be it appetite or lack of tangible security. Companies have also secured mezzanine financing when they are at an earlier stage in their growth cycle and exhibit cash flow constraints and need flexible loan terms. This type of funding may also be appropriate when a company needs growth capital but is not growing fast enough or is not large enough to attract venture capital or private equity.
Whilst mezzanine finance can be pricier than traditional debt, which generally reflects the risk profile of the transaction, it can provide a “one-stop” debt solution, allowing businesses to concentrate on growth rather than worry about early capital repayments.
- What are the benefits of mezzanine financing vs other forms of capital?
The structure of a mezzanine loan can be flexible and tailored to the needs of the business. Debt usually comes in the form of a fixed interest and capital repayment profile. Both the business and lender know what payments are due and when the debt will be cleared.
Whilst equity can be seen as an investment in future growth and value. The business owner can choose to sell a percentage of equity and this allows the investor to align their corresponding share of ownership with the growth aspirations of the business.
Mezzanine financing can be substantially less expensive than equity financing. By utilising mezzanine debt in its balance sheet, a company can lower its overall cost of capital. It can also allow a business to leverage its growth profile and assets to a greater extent than would ordinarily be possible with traditional senior (bank) debt.
- How do I obtain mezzanine financing?
To obtain mezzanine debt financing, you need the right partner. Prospective funders will look to understand your growth story – illustrating how new clients, orders or even new markets will help propel growth of the company. A business must also have a good understanding of the cash impact when obtaining mezzanine debt to help support this growth. Mezzanine loans are often more flexible than traditional debt finance, funders will look for comfort that growth aspirations are achievable and there is sufficient cash to repay the loan at the end of the term.