Business owners have many options for funding different aspects of their operations. Each option comes with its own set of pros and cons, and mezzanine financing is no different. For some situations – such as growth opportunities that need spot financing – this type of capital can be an effective option.
What Is Mezzanine Financing?
For those familiar with architectural terminology, you might infer that mezzanine financing is a sort of intermediate-level funding option. Mezzanine capital is a form of unsecured debt that usually comes with a higher rate of interest than what you would find on a debt instrument offered by a senior lender. This is because the borrower is not offering collateral as security. Also, mezzanine capital has flexible repayment terms; it is not uncommon for mezzanine borrowers to delay paying interest for several years after obtaining their funding.
One benefit for borrowers is that the principal is often a larger amount than they could receive from more conventional lenders. If the borrowing company goes under, though, the mezzanine lender is pushed toward the back of the line; senior debt lenders get first dibs on assets and property previously used by the borrower. Mezzanine lenders, however, will often negotiate terms (known as warrants) that allow them to convert the outstanding balance of their loans into a form of equity in the borrowing company under certain circumstances.
Example of Mezzanine Funding
Let’s say you have your eye on a company that will cost $50,000,000 to purchase. You are able to secure $40,000,000 from a traditional lender. For the rest, you could commit the capital yourself, if you have it, or you could borrow mezzanine capital for the remaining $10,000,000. In exchange, you accept an interest rate of 15 percent and a warrant that allows the lender to use the debt’s outstanding balance as an equity instrument.
Conclusion
As with all forms of commercial funding, there are tradeoffs to scrutinize before pulling the trigger on mezzanine funding. If you need legal advice about your company’s business deals, contact Integrated General Counsel by calling us at (925) 399-1529 or visiting our website.
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