Mezzanine financing: Its meaning, pros, and cons

The mezzanine financing is a form of debt that can be an excellent tool to finance specific initiatives such as the expansion of facilities or the launch of new product lines as well as other major strategic initiatives. Strategic initiatives can be the purchase of a commercial partner or the acquisition of financing dividend payments to the Shareholders or the completion of a financial restructuring to reduce debt payments.

It is typically used in combination with bank-issued term loans, revolving credit lines, and equity financing or can use as a substitute for bank debt and equity financing.

This type of capital is considered “lower” regarding seniority payment on the senior secured debt but is higher than the capital or common stock of the Company. In a capital structure, it is lower than senior bank debt but higher than equity.

Pros

The lenders of mezzanine finance are cash flows. They do not focus on guarantees. These lenders usually grant loans based on the company’s cash flow and not on guarantees (assets). Therefore, they often give money if banks do not do so if an entity has no material guarantee, provided the company has sufficient cash flow to cover interest and principal payments.

It is a cheaper financing option than capital procurement: prices are less high than the capital gains of investors such as family offices, venture capital companies or private equity firms, so owners may give up less capital to finance their growth.

Flexible capital that cannot be written off: There are any immediate capital payments. Typically, it is an interest-bearing capital with a total payment due on maturity that allows the borrower to use the money that would be used for the principal payments and re-invests it in the asset.

Long-term capital: Usually it has a term of five years or more. Therefore, it is a long-term financing option that does not need to repay in the short time. Usually, you cannot use it as bridging loan finance.

The current owners remain in control: no ownership or change of control is required: the existing owners and shareholders stay in power. It is a fundamental difference between obtaining mezzanine financing and raising capital from a private equity firm.

Cons

More expensive than bank debt: Since lesser capital is often not guaranteed and loan commitments by banks are subordinated and constitute a riskier loan, it is more expensive than bank debt.

The guarantees can include: To take on higher risk than most guaranteed lenders, intermediary lenders often seek to participate in the success of those who lend money and can consist of guarantees that enable them to increase their returns when the borrower has a good performance.

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