Mezzanine Finance
Mezzanine finance is normally used where the risk to the lender is higher than would be accepted for a standard business loan but where equity is not suitable, for example where the need for finance is shorter term.
Mezzanine finance is effectively a business loan where the debt becomes an equity share after an agreed timeframe has passed. If the business is unable to repay the loan as planned, the lender swaps the loan debt for a share of equity instead.
In other variants, mezzanine finance can be a mix of debt and equity where the lender benefits from a share of profits or growth as well as interest payments. It can also be structured to be repaid as one lump sum in some situations and in others the interest payments can be deferred.
Mezzanine finance has different characteristics to a conventional debt loan. Lenders tend to undertake less due diligence, while the borrower puts up a small amount of collateral. It is mainly used by established businesses which need to scale up but can’t secure all the finance they need from a traditional loan, rather than by start-up or early-stage firms.
As well as being unsecured, the loan also takes a subordinated (or junior) obligation in a company’s capital structure. The senior lender will have the ‘first charge’ on any assets and will be repaid first. That means the mezzanine financing is only repaid once senior obligations have been met should the company go out of business. However, mezzanine finance is repaid before common equity (the investments made by common shareholders).
Since mezzanine loans are riskier for lenders, the cost is usually higher than the interest on a standard loan.
Mezzanine finance has traditionally been used for larger, complex deals such as management buy-outs but there are now mezzanine funds which focus on smaller enterprises and offer advances of between £15,000 and £5m. Some may be suitable for the needs of SMEs.
A business is more likely to secure mezzanine funding if it can demonstrate an established reputation, a track record of success and a viable plan for growth. Generally, lenders are willing to look at any SME that demonstrates the following characteristics:
- An established businesses with sustainable operating profits and positive cash generation
- A strong position in a growth market
- A scalable business model generating strong margins
Due to the more complex nature of mezzanine finance businesses should consider seeking help from a local corporate bank, accountant or advisor to explain the options in more detail.
