What Is a Mezzanine Loan?

Some investors negotiate to receive additional profit participation. The principal is repaid at the stated redemption date, usually after that of mezzanine debt. A preferred equity investor may, however, have broader corporate approval rights because it does not have lender liability issues. A private equity firm often offers the cost of capital as a way to get majority ownership or complete ownership.

Unlike senior debt or asset-based financing, mezzanine financing is not secured. Instead, in the event of default, lenders will be able to convert their loans into equity shares. Mezzanine financing is a type of corporate debt that includes an equity component. It offers advantages to both borrowers and lenders that are not available through issuing stock or conventional debt, such as bonds. Established companies often use mezzanine financing to pay for an acquisition or launch a major project. Lenders participate for its higher interest rate and the possibility of part ownership in the borrower.

Mezzanine Debt: Definition, Overview & How It Works

But it’s also ideal for funding various other necessities in business. You might need to restructure your company from the ground up, which requires capital. So this is why mezzanine financing is sometimes called “bridge financing.” Also, because mezzanine financing can buy assets and grow a company, it can be pricey. Shareholder Buyouts are a great option for family-owned businesses that want to repurchase shares sold to them.

• This hybrid nature allows investors to benefit from the stability of senior debt, while also enjoying potential upside through equity-like features such as equity kickers and warrants.
• Lenders and their investors like the higher return and flexible payback terms.
• The stock will pay periodic dividends when funds are available until the defined maturity is reached.
• Mezzanine debt is most often used in mergers and acquisitions (M&A).

Unlike equity, mezzanine debt has a fixed interest rate and repayment terms. Mezzanine loans can be an excellent option for businesses that need access to quick funding to extra funding above what they can qualify for with traditional bank loans or financing companies. Although they are typically more expensive than senior debt, these loans offer more flexible repayment terms and less paperwork than traditional loans.

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At the same time, the interest rate is lower than equity regarding the overall cost of capital. Mezzanine financing is NOT meant to be a long-term source of capital – instead, mezzanine financing is short-term funding for companies with a specific purpose (e.g. LBO financing, growth capital). Mezzanine Financing is an alternative form of hybrid financing that blends features of debt and equity. Common examples include 2nd lien debt, senior/subordinated bonds, and preferred stock.

Benefits and Drawbacks to Borrower

Get instant access to lessons taught by experienced private equity pros and bulge bracket investment bankers including financial statement modeling, DCF, M&A, LBO, Comps and Excel Modeling. For acquiring companies, mezzanine capital is a cost-effective alternative to financing M&A expansion through raising outside equity. In contrast, the securities placed at the bottom of the capital structure possess the most risk, so the required rate of return is greater. Mezzanine debt typically has a lower priority than senior debts when borrowers go bankrupt. There are estimated to be over 1,000 mezzanine finance lenders in the United States, so there is scope for a wide range of different terms for a company’s mezzanine finance requirements.

One special aspect of mezzanine loans is that senior lenders may be able to stop interest payments on the mezzanine debt in the event of the company being placed under financial stress. This is to protect the senior lenders, who are receiving a lower https://personal-accounting.org/what-is-mezzanine-financing/ return than the mezzanine lenders, who are taking on more risk. Mezzanine financing is more expensive than senior debt and cheaper than equity, but is a relative hybrid of the two, so it is priced as a blend of both senior debt and equity.

What Is a Mezzanine Type Loan?

They may also have some form of participation rights, such as warrants, in the common equity of the business, though in a manner that will be far less dilutive of ownership than the issuance of common equity. This hybrid structure allows companies to access additional capital without diluting existing ownership. Secondly, mezzanine debt often carries a higher interest rate and warrants, providing attractive returns for investors.

How to Tell If You Qualify for Mezzanine Financing

Mezzanine loans assist in generating more capital for a business in addition to allowing it to increase its returns on equity and show a higher bottom-line profit. Mezzanine loans typically do not require payment during the term of debt, only at the end of the term. The company can also use the additional available funds to pay off other existing debt, invest working capital, develop products or finance market expansion.

Mezzanine financing is a form of funding that combines debt and equity. It provides the lending entity the right to convert a loan into equity in the case of a default. Mr. Arora is an experienced private equity investment professional, with experience working across multiple markets. Rohan has a focus in particular on consumer and business services transactions and operational growth. Rohan has also worked at Evercore, where he also spent time in private equity advisory.

SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. SmartAsset does not review the ongoing performance of any RIA/IAR, participate in the management of any user’s account by an RIA/IAR or provide advice regarding specific investments. Company Y gained more working capital to bring more water bottles to the market and paid off higher-interest debt. Hence, the mezzanine layer reduces the equity requirement and helps to secure more total capital.