Mezzanine financing is a hybrid of debt and equity financing that gives the lender the rights to convert to an ownership or equity interest in the company in case of default, after venture capital companies and other senior lenders are paid. Mezzanine financing, usually completed with little due diligence on the part of the lender and little or no collateral on the part of the borrower, is treated like equity on a company’s balance sheet.
To attract mezzanine financing, a company usually must demonstrate a track record in the industry with an established reputation and product, a history of profitability and a viable expansion plan for the business, such as through expansions, acquisitions or an initial public offering (IPO).
A typical interest rate for mezzanine financing is 12 to 20%, making it a high-risk, potentially high-return debt form. Mezzanine financing typically replaces part of the capital that equity investors would otherwise have to provide a company. For example, a private equity firm is purchasing a $200 million business. Senior lenders agree to provide $150 million. The private equity company secures mezzanine financing for $20 million and puts in $30 million of its own funds for the buyout. By using mezzanine financing, the purchasing company leverages its return while contributing less of its own capital.
Mezzanine financing may result in lenders gaining equity in a business or warrants for purchasing equity at a later date. This may significantly increase an investor’s rate of return (ROR). In addition, mezzanine financing providers receive contractually obligated interest payments monthly, quarterly or annually.
Borrowers prefer mezzanine debt because the interest is tax-deductible. Mezzanine financing is more manageable than other debt structures because borrowers may figure their interest into the balance of the loan. If a borrower cannot make a scheduled interest payment, some or all of the interest may be deferred. This option is typically unavailable for other types of debt. In addition, quickly expanding companies grow in value and restructure mezzanine financing into one senior loan at a lower interest rate, saving on interest costs in the long term.
However, when securing mezzanine financing, owners sacrifice control and upside potential due to the loss of equity. Owners also pay more in interest the longer mezzanine financing is in effect.
Rates and terms can change without notice. All transactions are subject to underwriting and written approval.