Mezzanine Capital Loans against Equity | Small Business Loan Central

Mezzanine loans are types of hybrid financing that combine the characteristics of equity and loan. The loans are subordinate to various levels of secured junior debt and senior debt. The loan given is financed from subordinated debt, senior subordinated debt, senior debt, mezzanine debt and the owner’s equity. This subordinated position can easily make people confuse a mezzanine loan with a subordinated loan. Subordinated loans are not paid until the primary loan obligations have been met when bankruptcy is declared.

Mezzanine financing is a special type of subordinate loan where the terms are more specific.It is provided in a kind of joint venture in exchange for some level of equity. The lender makes some decisions in the operations of the company, with the contract stipulating the level of involvement.

Many borrowers take advantage of mezzanine financing to get additional funds for financing asset acquisitions, refinancing existing debts, protecting their equity upside or improving their overall return. (2) This method is often used to finance buyouts and acquisitions in the commercial real estate market, especially considering first-mortgage lenders are hesitant to provide funds at loan-to-value ratios of more than 65%.

People interested in expanding their businesses may consider mezzanine financing because of the opportunity to increase debt without relinquishing equity ownership. Mezzanine financing leads to a slight increase in debt expense ratio with a corresponding marginal fall in equity ratio.

The Pros of Mezzanine Financing

• Being a type of joint venture, the borrowers do not lose outright control of their companies. While they sacrifice some independence, they do not lose majority control of their companies, effectively protecting their ownership rights.
• As long as the business prospers, the mezzanine lender will hardly interfere with the operations of the company.
• Borrowers have the opportunity to conserve money because of interest-only payments. Fixed-interest covenants make it easy to plan proper budgets.
• The loans are flexible and structured to match the needs of the business.
• The loans are available to people who cannot get capital by using other methods due to lack of collateral among others.

The Cons of Mezzanine Financing

• Mezzanine lenders take higher risks, which attract higher interest rates. The loans are therefore more expensive than the conventional ones.
• It usually takes relatively long to secure the required capital because of the lengthy negotiation process.
• The subordinated debt portion may come with restrictive agreements.
• Mezzanine lenders often require board seats. However, they usually do not have voting powers.
• The value of stock existing shareholders have will increase although the equity will somewhat dilute it.
• The lenders often provide strategic help to their borrowers.