How Does Mezzanine Financing Work?
A mezzanine loan is ideal for businesses with the potential for years of growth and sustainability. It complements other forms of funding on projects.
Is mezzanine financing right for you?
The UK's mezzanine financing sits between debt and equity financing.
Mezzanine capital can be complicated, and mezzanine finance providers can offer various models. Loans are secured by equity shares in the company. When loan repayments are not fully repaid, lenders may convert them into equity or company shares. Equity may also be accepted by the lender in case of default on repayment.
In general, mezzanine capital is more beneficial to SMEs with ambitious growth plans than to start-ups. It is important to have a strong business plan that demonstrates years of continuous growth and sustainable profitability in order to appeal to financiers.
Lenders commonly use mezzanine capital in management buyouts and property development, where they make long-term investments. SMEs are increasingly getting loans from mezzanine funds.
Mezzanine financing: how does it work?
Mezzanine financing often complements other sources of funding. An investor’s agreement may trigger a senior lender to offer a ‘top-up’ loan.
Mezzanine financing involves debt seniority. In a company’s capital structure, mezzanine loans are below senior loans. Once your senior loan is repaid, you can apply for a mezzanine loan.
It’s important to keep in mind that your growth plan could determine the future ownership of your company. A mezzanine lender may convert debt into equity if your revenue stalls and you struggle to make repayments.
What is the cost of mezzanine financing?
Most mezzanine loans have a higher interest rate than conventional UK loans. Sometimes interest rates reach 20%. Rates above 10% are normal. Why is it so high? Investors need to be aware that this type of financing carries a significant amount of risk since the debts are subordinated to the senior debt.
Business success will result in mezzanine lenders receiving their high-interest payments. If you succeed, lenders will increase their stake in your business due to defaulted loans. Individual arrangements may require monthly, quarterly, or annual interest payments.
Tax deductions for mezzanine finance debt can also affect company accounts.
Further, some financing arrangements enable borrowers to defer repayments.
Finally, if the proposed business plan succeeds and the company grows as planned, you might be able to convert mezzanine funding into senior debt at a lower interest rate.
Mezzanine financing takes how long?
Mezzanine financing can be quite complicated. Several weeks or months are likely to pass. Financial planning should include extended financing arrangements.
I need a mezzanine loan. What kind of security do I need?
In mezzanine financing, security is not always needed, because certain lending conditions may allow the lender to receive equity in the company. Thus, the borrower usually needs little additional security.
A UK mezzanine lender may also require collateral or a personal guarantee. Finance applications vary depending on their individual circumstances.