Mezzanine finance

Mezzanine finance is a combination of debt and equity financing which can be useful for large projects, management buyouts or growing businesses. It’s a pretty complex form of business loan. 

For businesses looking to raise money, there are two basic routes: debt, where you borrow money using a business loan; or equity, where you sell a share of your business in return for cash.

Mezzanine finance covers a range of complex funding scenarios and for certain situations it can make more sense than either debt or equity in their pure forms.

Why mezzanine financing?

Mezzanine finance is normally used in situations where the perceived risk is high enough that the borrower can’t raise enough money through a traditional business loan. The alternative would usually be equity finance — but many companies don’t want to give up shares in their business.

Mezzanine finance allows such businesses to borrow a larger amount which, if things go to plan, will be paid for through profits gained. Put simply, it allows a bigger investment aiming at a bigger return.

Mezzanine finance is repaid as one lump sum in some situations, and in others the interest payments can be deferred. Mezzanine finance may also have tax-deductible interest.

All these factors make mezzanine finance a little bit different to a normal business loan.

How does mezzanine finance work?

Mezzanine finance is effectively a business loan where the debt becomes an equity share after a predetermined time- frame has passed. That means if the company can’t pay back the funding, the lender gets a share of equity instead. In this way, equity in the business is used as security.

In other contexts, mezzanine finance blends debt and equity by offering a share of profit as well as interest payments. In other words, the business borrows money, and in return the lender gets a share of the benefits.

Benefits of mezzanine finance

Mezzanine finance is often used as a kind of ‘top up’ in addition to the amount provided by the main lender. For example, if the main lender provides 65% of the amount you need for a project, mezzanine finance might provide a further 20% — leaving just 15% for the business to put in.

Or, mezzanine finance is a method of raising more capital with the same amount to put in yourself — it’s often the facilitator for bigger projects that the business couldn’t otherwise afford.

The result of such a setup is that the business can achieve the maximum return with the cash contribution they have available. Working capital levels are hugely important for any business, so mezzanine finance can be a welcome addition to the standard financing arrangements.

Mezzanine finance for MBOs and LBOs

Mezzanine finance can also be used for management buyouts (MBOs) or leveraged buyouts (LBOs). These arrangements work in a similar way to standard mezzanine finance, but instead of a single asset, property or project it’s an entire business being financed.

LBOs and MBOs depend on specific circumstances of the business being bought so it’s tricky to generalise, but overall they’re a way to use the value of the business being bought as the security.

Conclusion

Mezzanine finance is clearly a complex product, but it has its uses. If you’re looking for mezzanine finance, or just researching the various ways to fund a project, we can help you.