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There are three basic categories of business funding. The most common, debt funding, is the name given to finance where you borrow money (take on a debt) for an agreed rate of interest.<\/p>\n
With equity fundraising, you offer a portion of your business in exchange for finance. <\/p>\n
The third category, known as \u2018mezzanine finance\u2019 offers something of a balance between the other two.<\/p>\n
In this article we\u2019ll explore what it means, and how best to use mezzanine financing to grow your business<\/p>\n
Mezzanine financing is a complex type of property finance that covers a range of funding scenarios. For certain situations it makes more sense than either debt or equity funding, particular where the borrower can\u2019t raise enough money via traditional means. <\/p>\n
This type of finance is commonly used for larger finance amounts whereby the money borrowed is intended to be repaid through profit gained. The loan is originally offered as cash with a portion transforming into equity after an agreed timeframe has passed.<\/p>\n
Effectively, the company is therefore using it\u2019s own equity as loan security. <\/p>\n
The lender would also benefit from interest payments on the amount loaned.<\/p>\n
Mezzanine finance is a hybrid of both debt and equity. With this type of funding the lender provides a second charge (subordinated) loan, plus the potential for equity should the loan extend beyond a certain point.<\/p>\n
This type of finance means that this loan will rank after some other debts should the company fall into liquidation.<\/p>\n
Anyone with a first charge (or first \u2018lien\u2019 in US terminology) would be paid before the lender of a subrogated debt. In the UK, a subordinated loan is more commonly referred to as a \u2018second charge\u2019 loan.<\/p>\n
Typically, mezzanine finance lenders would be paid after \u2018senior debt\u2019 holders, but before common equity.<\/p>\n
In commercial property deals, mezzanine funding has a particular place because the property itself can be used as equity.<\/p>\n
Its useful for property developers because it faciliates significant finance deals, while placing the investment property itself as collateral.<\/p>\n
Deals like this usually come with terms of between 1 and 5 years, though in certain cases they may go up to 10.<\/p>\n
They\u2019re popular because the centrality of a property with a verifiable market value gives lenders immediate security and can hence fastrack loans of this type.<\/p>\n
What are the typical interest rates you\u2019re likely to find in mezzanine finance deals?<\/p>\n
10 to 30% would be a common range: the higher rates correspond to the fact that equity is offered in lieu of cash. While this denotes a certain level of security it still takes time for a lender to translate into cash should the worse occur. They therefore cover themselves via a higher interest rate.<\/p>\n
As with bridging finance, mezzanine funding is preferable for large, profitable deals where this kind of percentage interest remains worthwhile.<\/p>\n
Senior debt is the terminology for a debt which carries a \u2018first charge\u2019 over a particular security. This means, should you default, this lender will have the primary right to be paid, over other lenders.<\/p>\n
Mezzanine debt, by contrast, is a kind of hybrid debt, made up of part loan and part investment. The money lent via mezzanine funding carries a second or \u2018subordinate\u2019 charge, meaning these lenders carry more risk.<\/p>\n
It is to balance this risk that mezzanine lenders are assigned equity in the company should their debt not be repaid within certain terms.<\/p>\n
While we are frequently asked this question, it\u2019s a tricky one to answer in a concrete fashion. No finance is completely safe since it exists within a marketplace that is constantly shifting within broader economic forces.<\/p>\n
The key points with mezzanine finance is that it is often unsecured, and with a higher interest than senior debt. Part of the return is always fixed, which makes it less dilutive than a standard equity finance deal.<\/p>\n
No principal\u00a0amortization\u00a0exists on this type of finance, meaning you only pay monthly interest, rather than paying the interest and principal in different amounts each month.<\/p>\n
Business Expert is a specialist at finding specialist finance, at the best rates, for the property development sector.<\/p>\n
With whole of market access at fingertips, we can help you source the right lender for your particular situation.<\/p>\n
Please make contact with us via our enquity form, and one of our experienced brokers will be in touch to explore how we can help.<\/p>\n