You’re ready to take the next big step for your business—maybe you’re looking at an acquisition or moving to a bigger location. You’re weighing your financing options, and you might even be facing a funding gap before you can make the next move. This is where mezzanine financing can help.
With mezzanine financing, you’re in the driver’s seat. Unlike some financing options that demand a stake in your company, this form of financing ensures you retain majority control. Your vision, leadership, and the core essence of your business remain uncompromised.
Mezzanine financing is also making a comeback: $30.1 billion was raised in mezzanine funds across the globe in 2022, marking a doubled increase in this type of financing since 2021. Business owners have demonstrated interest in this funding option, and that interest is only growing.
In this blog, we’ll go into what mezzanine financing is, what businesses use it for, some of its benefits and disadvantages, and if bridge loans and mezzanine financing are, in fact, the same thing. (Hint: They’re not.)
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What is mezzanine financing?
As a unique financial tool, mezzanine financing is designed specifically for businesses like yours, bridging the gap between traditional bank financing and equity investment.
This is a powerful option for businesses that have outgrown their initial funding stages but aren’t quite ready for large-scale equity investments.
Mezzanine financing, named as such because of where it lies between senior debt and equity, is a hybrid form of financing, which allows your lender to convert your existing debt into equity in your company.
Senior debt refers to financing that has the highest repayment priority if a company were to go bankrupt or default. Since mezzanine financing is considered lower priority than other financing options, lenders will often charge higher interest rates in exchange for the risk they take on. Take a look at the chart below to see a couple different categories.
|Tip: Mezzanine financing and senior debt are terms often used interchangeably, but actually mean two different things!|
Mezzanine debt, on the other hand, is a form of debt, that is between debt and equity. Like a working capital loan, you borrow a lump sum of money which is repaid, typically with interest.
However, mezzanine debt is often used for larger, long-term purposes and comes with higher interest rates than senior debt. Despite the high risk associated with this kind of debt, it can have a high rate of return, ranging from 12% to 20% per year. Let’s put this into context with a thought experiment.
Say you’re looking to expand your business, you need more capital than a traditional lender might be comfortable loaning you and they require you to invest funds as well.
Now, let’s say your lender expects you to invest 10% of your own money, and they have agreed to loan 50% of the remaining balance. This sounds good to you, but where can you get the remaining total from? A lender that can provide the remaining funds to you is known as mezzanine debt.
How mezzanine financing is structured—at a glance.
What do businesses use mezzanine financing for?
With such a unique form of financing, you might be wondering what you can use it for. (Including some ideas you hadn’t thought of previously.) Let’s take a look.
Harnessing growth potential.
Every business dreams of scaling new heights. Whether it’s fueling rapid organic growth or kickstarting innovative growth strategies that require significant capital upfront, mezzanine financing provides the robust backing you need to turn these aspirations into reality.
Empowering business expansions.
Acquisitions are a strategic move to expand your business footprint. When you’re eyeing a new business acquisition, mezzanine financing ensures you have the capital muscle to make that acquisition seamlessly.
Facilitating smooth transitions.
Business transitions, be it buying out a partner or a shareholder, can be pivotal moments in the lifespan of your business. Mezzanine helps ensure these transitions are smooth, without financial hiccups.
Buyouts, whether leveraged or managed, are significant business moves. Mezzanine financing offers the financial strength to support these buyouts, ensuring your business strategy remains uncompromised.
In essence, mezzanine financing is not just a financial instrument; it’s a strategic ally, empowering businesses to navigate diverse situations with financial confidence.
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How your business can benefit from mezzanine financing.
Retain control of your company.
Your vision and leadership have steered your business to where it is today. With mezzanine financing, you can continue to lead with confidence.
Unlike some other financing options, mezzanine financing ensures that you, as the existing owner, retain majority control. This means you maintain your influence over both the board and management, ensuring that the core values and direction of your business remain firmly in your hands.
Tap into the opportunities of larger deals.
When you’re eyeing a property purchase, senior lenders might not always offer the full capital you need. This is where mezzanine loans come to your rescue. They seamlessly fill the financial gap, empowering you to make those larger, more ambitious investments that can propel your business forward.
Work with an alternative source of capital.
In your journey to grow and sustain your business, having diverse financial resources is crucial. Mezzanine financing steps in as a potential alternative capital source for you. It complements senior debt and equity, ensuring you always have a well-rounded financial toolkit at your disposal.
This versatility empowers you to make strategic decisions with confidence, knowing you have multiple avenues of capital to rely on.
Maintain your financial upside.
You’ve worked hard to grow your business, and the potential increase in value shouldn’t slip through your fingers. Unlike equity, which can lead to a loss of this potential upside, mezzanine financing ensures you retain it. Plus, it even offers avenues for leveraged buyouts if your partnership agreement permits, keeping you in control.
Keep your repayment options flexible.
Your business is unique, and so are its financial needs. Mezzanine financing offers you a variety of structures. Whether you prefer repaying through equity provision, adding interest to the loan balance, or straightforward cash payments, the choice is yours.
This can be cost-effective.
Mezzanine financing offers you a cost-effective alternative to direct equity issuance, which can be both expensive and dilutive.
Plus, while institutional equity often expects returns of 20% or more, mezzanine financing provides a more balanced approach, ensuring you get the capital you need without compromising your financial stability.
Disadvantages of mezzanine financing.
There are a few downsides to mezzanine financing that you should be aware of, however.
Matters of equity.
Let’s start with the good news: The costs are generally going to be lower with this kind of funding than if you were to go with an entirely equity investment. If you’re looking at a lower interest rate for mezzanine financing, you likely need to offer more equity.
High interest rates.
As we’ve already discussed, since mezzanine financing is secondary to senior financing, there’s a higher risk for your lender, and you’re likely to encounter higher interest rates.
An example of mezzanine financing.
Building on the brief example we provided earlier in the blog, let’s take a look at a more in-depth example of mezzanine financing.
Say you’re looking to acquire a new business to further build out your own. Let’s assume you were looking to raise $15 million in financing for the acquisition. Once the acquisition is completed, you’d be in a good spot to repay your lenders.
One lender might be willing to loan you up to $10,000,000. You’re still facing a funding gap of $5,000,000.
This is where mezzanine financing can be a huge help. The lenders you go to for this kind of funding are facing a much higher risk, and as a result, your interest rates are going to be higher. (Even though the total amount of debt is less than what you’re borrowing from your senior lender.)
Are bridge loans and mezzanine financing the same thing?
The short answer? Though they might be used for similar reasons, they’re fundamentally different.
When you’re faced with short-term financial gaps, perhaps while waiting for a property sale to finalize or securing another form of longer-term financing, bridge loans come to your rescue. They’re your go-to for those immediate, short-lived financial needs.
On the other hand, mezzanine loans are there for you when you’re eyeing bigger ventures. Whether you’re getting into property development, considering a business acquisition, or exploring new investment avenues, mezzanine loans offer the backing you need. They’re not typically your choice for fleeting financial gaps but rather for substantial, long-term endeavors.
Plan for the future with Credibly.
We recognize the unique financial needs of your business. Although we don’t provide mezzanine financing, we’re equipped to help you assess if this is the right path for you.
Our commitment is to understand your business’s potential beyond just the numbers. We’re here to offer insights and guidance—not just financing.
If you’re considering your next financial move and wondering if mezzanine financing fits your growth strategy, let’s discuss your options.
With experience supporting over 30,000 businesses, we’re prepared to help you make an informed decision.
Begin exploring your financing possibilities with Credibly today.
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