Benefits And Disadvantages Of Mezzanine Financing By Chad Pitt At Isnare.com Ezine Articles

What is Mezzanine Financing?

Mezzanine financing is a hybrid of debt and equity financing. It is most often used as a way for companies to finance their expansion costs. It requires timely payments on the loan or the lender is entitled to ownership or equity interest in the company. Most mezzanine loans are made with little or no collateral or paperwork from the borrower, thus interest rates are much higher than traditional loans and tend to be short-term.

What are the benefits of Mezzanine Financing?

Most banks and financing institutions lend money based on the cash flow of the company. In many situations, the company’s cash flow will not sustain what they are trying to accomplish making traditional loans and debt financing impossible to obtain. In the past many companies looked to equity investors as an alternative option, however equity can be the most expensive source of capital due to the fact that ownership in the company must be exchanged for the capital. Mezzanine financing allows business owners to get the dollar amount they need while giving up little or no ownership of the company as long as they are able to pay their debt in a timely manner and in full.

Also, mezzanine financing is treated like equity on a company’s balance sheet which allows them to obtain traditional financing easier.

What are the disadvantages of Mezzanine Financing?

Because mezzanine financing is not collateralized and does not require long periods of time for verification, the lender is assuming greater risk than a traditional lender. This increase in risk tends to make mezzanine financing unavailable at most of the standard lending institutions. Instead, mezzanine financing is usually found through unconventional lending institutions which are looking for a return of at least 20%. As a result interest rates and terms of mezzanine financing can be much higher than traditional debt financing and may be structured with warrants and options.

Requirements

To qualify for mezzanine financing, a company must show a strong track record in the industry and be fairly well established with a good reputation. Also, mezzanine lenders will usually require a history of profitability so that they are confident that they will be able to get the return they are looking for as well as a detailed description of how the capital will be used to generate more income for the company and repay the lender.

Many companies interested in mezzanine financing include, but are not limited to companies who are looking to expand, acquire another company, or on the verge of an Initial Public Offering (IPO). In any financing scenario, mezzanine financing is an alternative option that should be carefully considered. It could be just what your company is looking for.

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