A guide to mezzanine finance

When it comes to loans and other forms of finance, we are generally aware of the main forms: guarantor loans, payday loans, mortgages and so forth, however…what about mezzanine finance?

For many, this type of funding remains shrouded in an element of mystery, but it really needn’t be.  Once understood, the concept is fairly simple to get to grips with and could very well be a fantastic way to help with financing a business you run. Here is our guide on everything you need to know about mezzanine finance.

What is mezzanine finance?

Mezzanine finance is a type of multi-tiered finance loan for businesses. It is considered to be a loan that sits in-between senior debt (considered a less risky sort of debt) and equity (considered higher risk than senior debt).  In many respect it is considered to be very much like equity on a business’s balance sheet.

This mixture of debt and equity financing is what makes the idea of mezzanine financing appealing to the lender. This is due to the fact the lender receives the equity interest in the company it borrows money to if the company is unable to keep up with repayments. It can also turn into complete ownership of the company if it defaults too.

So whilst there is a greater risk for the lender than through other types of lending, there are also advantages to doing so too. Whilst for the borrower, there are clear incentives for making sure they pay back promptly (losing potential ownership) as well as the less appealing alternative of equity finance (meaning having to give up shares in the business) so this provides benefits for both parties.

There are no guarantors typically involved with mezzanine funding – it is more like giving a stake away in your project or investment for a greater return.

What makes mezzanine finance different?

Another aspect of mezzanine financing that makes it different to other types of funding for businesses relates to the equity component of it. This part means that the lender will receive additional revenue from supporting the borrower’s company if it is able to make profits.

What are the benefits of mezzanine financing?

There are several advantages to using companies such as Iron Bridge Finance and Castle Trust who provide mezzanine financing services. Here are some of the main advantages:

• Mezzanine finance can be a less expensive alternative to other ways to finance growth in a company, especially if they entail an element of risk. This is due to the fact that companies can find it much more difficult to find funding from banks who tend to exert caution on risky finance strategies, meaning they can it be difficult for the business to go forward
• It has the ability to help in a broad rang of complex financing situations
• If you require extra capital, and  you are finding it difficult to get this, again from banks as you have gone beyond the capacity for senior debt borrowing, then mezzanine can provide a great alternative to help your business
• If you are looking to expand the company (perhaps through large capital programs, distributions or shareholder buyouts) it can be far easier to achieve this through mezzanine financing
• It can often be preferable for businesses as mezzanine debt can be tax-deductible
• There is often the possibility to be able to restructure mezzanine financing at a later date, as a result of the business growing in value. This means the borrower may decide to finance a senior loan at a lower interest rate, which can prove to be difficult to sort out without types of loans available on the market

What else do I need to know about mezzanine financing?

• There are interest rates that need to be taken into account when it comes to mezzanine financing. This is usually up to 20%
• Eligibility is a crucial factor when it comes to being accepted for mezzanine financing. Most mezzanine finance providers will require that you have a history of profitability, a thoroughly detailed expansion plan, and an established reputation within your industry
• It is important to take into account the potential risk you entail as a borrower should you default. You need to make sure that you feel that you would be able to keep up with repayments otherwise the potential to lose equity and lose ownership of your company could pose a very real threat

Is mezzanine finance regulated?

Yes and no. If you are lending on an individual’s primary residence, this falls under regulated activity by the FCA.  This is because someone’s house is at risk and therefore there needs to be special precautions – what rates are charged, what happens if you cannot repay, proper checking including credit checks and affordability.

When not regulated by the FCA, lenders still have to adhere to various codes, such as the MCD and a code of practice, but it means that they can lend on commercial properties or second charge residential properties without an FCA license.