What Is Mezzanine Financing and Why Is It Useful?
According to Merriam-Webster, the mezzanine definition is “a low-ceilinged story between two main stories of a building.”
This is actually where mezzanine financing gets its name. It’s a kind of financing between the two main types of financing of debt and equity. In fact, it often blurs the line between debt and equity finance.
Even though it’s seen as complex and high risk, mezzanine finance providers can be a useful alternative source of finance. Read on to learn more.
How to Generate Capital
Before we can go through mezzanine finance, it’s important that you understand the two main ways of generating capital.
1. Debt Finance
Debt finance is another way of saying you’re borrowing money. This mostly comes in the form of loans.
It usually works by the lender providing cash to the business in return for regular repayments. These add up over time to the initial loan payment, plus any interest.
2. Equity Funds
Another way of generating cash for your business is through equity funds. This refers to the selling of shares in your business.
After purchasing shares in the business, they own part of your business. Therefore, they benefit from growth and suffer the losses as much as you do.
As a result, this kind of investment is usually chosen by venture capitalists and private investors as a long-term strategy. It’s higher risk–but the benefits are potentially much greater than debt finance.
The Middle Way: Mezzanine Financing
Mezzanine financing is often seen as the middle way between equity fundraising and debt financing.
This is because it combines the risk elements of equity fundraising (which have the potential for higher returns) with the predictable aspects of debt finance.
No mezzanine financing arrangement is exactly the same. However, the most common type of arrangement is when a loan converts into a share in the business after an agreed period of time.
Therefore, if the business cannot pay back a loan, the lender can recover any losses by assuming equity shares in the business. This serves as a kind of collateral for the failure to pay back the loan.
Furthermore, mezzanine finance arrangements also allow businesses to obtain greater capital. This is because the lender has greater assurances that they will recuperate any costs.
Why Is It Useful?
Mezzanine financing is useful for many businesses looking to generate capital for projects.
These arrangements often result in the owners giving up some equity shares. Still, this rarely results in the owners losing majority control of the business.
Therefore, it doesn’t affect the day-to-day decision-making of the owners.
Generating capital is difficult for many businesses. Mezzanine financing provides businesses with flexibility in terms of repayments. The middle-way of mezzanine finance can sometimes be the key to getting a project going.
The Bottom Line
Mezzanine financing is a useful way for businesses to generate capital for projects.
It provides the hybrid system between selling off portions of your business as equity shares or simply taking out a loan.
If you enjoyed reading this post, check out our other business blog posts.