A business has to grow its capital to reach its goals of the business. This requires debts and investors to be interested in investing in it. There are different types of debts that can be obtained from banks and lenders. Such burrowing options include senior debt financing, equity financing, and mezzanine financing.
What Is Mezzanine Financing?
Mezzanine financing also called subordinated debt or financing is burrowing with a fixed rate coupon or dividend. It allows the lender to covert the debt into an equity debt after the other senior and equity debts are paid by the company. In other words, mezzanine financing exists between senior financing and equity financing.
Key aspects of mezzanine financing
Companies use mezzanine financing to fund specific projects of the business and use it as an option for senior and equity debts. Investors get between 12% and 20% a year as returns when mezzanine financing. Therefore, some investors prefer lending money as mezzanine debts. Most established companies get the opportunity to get this financing than start-up businesses. The interest in mezzanine financing can be lowered due to market interest rate drops.
Advantages of Mezzanine Financing
Mezzanine Financing is a good choice for lenders and investors as it usually gains higher interest rates and later can be used to buy equity. This increases the lender’s rate of return. The investors can receive their gains monthly, quarterly, or annually.
The burrowers consider Mezzanine Financing as a tax-deductible business expense. It reduces the weight of the debt and relief for a business to reduce its liabilities. Mezzanine Financing is more manageable than the other financing options.
When a company is in search of a quick way of obtaining funds for a project or to expand the business in a hurry, Mezzanine Financing is a great way of getting access to such required funds. Companies can restructure mezzanine financing loans into one senior loan upon company growth, for a lower interest rate.
Disadvantages of Mezzanine Financing
The burrowers end-up paying higher interests for the lenders in Mezzanine Financing. It also gives some control to the lenders over the business. Sometimes, this can be disadvantageous for a company. As the lenders have a long-term deal with the company, they can be interfering with the business process and even insist on a board presence.
The loan agreements of the Mezzanine Financing are strict and include restrictive covenants. This can limit the opportunity to burrow extra funds and additional debts in need from other burrowers. Such limitations can be stressful as they can limit the business growth to some extent.
The lenders also have the risk of losing their funds in Mezzanine Financing due to the bankruptcy of the company. If a business goes out of business, the debts are paid back in an order where the senior debt holders get paid first. If the company runs out of funds on such occasions, the mezzanine lenders may lose out.
Mezzanine Financing is a good choice for a rapidly growing company. But the risks are at a higher level. If a business can handle such risks, mezzanine financing can be the best option for them.