Could mezzanine finance help your business grow?
Read our fast guide to the loan/equity hybrid
Although it is generally a more expensive source of funding than a straightforward bank loan, mezzanine finance can be particularly useful to fast growth companies or businesses involved in leveraged buy-outs.
What is mezzanine finance?
Mezzanine finance is something of hybrid, standing between combining elements of a conventional bank loan (senior debt) and equity funding. It works like this. A mezzanine finance provider is essentially lending you money. However, the arrangement will also involve an element of equity. What this means is that in addition to receiving fees and interest on the loan, the provider also benefits from a share of the upside when the borrowing business achieves its growth objectives.
Pros and cons
So why is this attractive? Well, in situations that banks and other lenders consider to be high risk, you may not be able to get sufficient funding via a term loan. The alternative is to seek capital from private equity investors, but that will involve surrendering equity.
In the case of a mezzanine loan, equity is typically granted to the lender in the form of a warrant that will provide a return on exit. This compensates the lender for the perceived higher risk. The key characteristic of a warrant is that it does not result in any dilution of your shareholding in the company. If you own 100% or 70% of your business, you will continue to do so.
Also important is the fact that the debt associated with a mezzanine finance arrangement is redeemed in a one-off payment rather than being paid monthly over a period of years. This means that on a month by month basis, the debt does not place a strain on cashflow. Indeed, the mezzanine element is often redeemed relatively painlessly on the back of a subsequent refinancing.
However, a mezzanine loan is more expensive. Lenders look for a yield of 3% of 4% above the base rate, plus the additional return based on the performance of the business. This compares to a rate for term loans of 1% 1.5% above base.
When is it appropriate?
Mezzanine finance is most often deployed in leveraged buy-outs to compensate for risk. The same logic can also be applied to the funding of early stage businesses. Mezzanine loans often sit as part of a larger finance package including term loans and equity finance.
The business divisions of the high street banks will talk to you about mezzanine finance, with RBS and HSBC particularly strong. Santander also has a mezzanine debt scheme worth looking into. Their Breakthrough programme has no equity component and instead customers are expected to make interest repayments. The rate is set at 5% over LIBOR paid quarterly and a further 5% rolling up.
Alternatively you can approach specialist providers such as Intermediate Capital Group.