Mezzanine Financing Explained

Mezzanine Financing Explained

Mezzanine financing, which has been around for the past 30 years, is becoming increasingly popular in European markets.As in the US, private equity investors in Europe are turning to mezzanine financing as a potential source of capital in financing their acquisitions and recapitalizations, management and leveraged buyouts, as well as to provide a funding source for growth capital. This article provides a brief explanation of mezzanine financing along its terms, structures, and common exit strategies. It also explores the various advantages of mezzanine capital for companies in the small and middle market sector.

What exactly is mezzanine debt?

Mezzanine debt capital generally refers to that layer of financing between a company’s senior debt and equity, similar to the mezzanine layer in a building. Structurally, it is subordinate in priority of payment to senior debt, but senior in rank to common stock or equity. Mezzanine debt is used by companies during a transitional phase when they need more capital than they can get from a bank. Through intelligent deployment of the mezzanine capital, a company will be able to significantly increase in size and therefore in value. In this vein, the mezzanine debt is transitional capital that enables rapid growth in a short period of time.

Typical mezzanine terms

Mezzanine financings generally tend to be highly negotiated transactions and are mostly customised for the particular situation.Commonly negotiated mezzanine terms include those related to type of instrument, maturity, interest rates and fees, ranking in the capital structure, collateral, covenants, redemption and call protection, equity participation and transferability.

Basic mezzanine structure

Most mezzanine financings are completed through a variety of different structures based on the specific objectives of the transaction and the existing capital structure in place at the company. Mezzanine lenders look for a certain rate of return, which can come from a combination or any one of the following sources, namely, a periodic payment of cash, a PIK interest, an equity stake in the form of attached warrants, or a participation payout in the form of a percentage of the company’s performance.

Common mezzanine exit strategies

As far as a mezzanine exit is concerned, most mezzanine investments are taken out either through a refinancing or a recapitalization of the company. Very rarely do mezzanine capital providers look to invest in companies that represent strong IPO candidates. More often than not, mezzanine exits take place through a recapitalization by the initial owner with inexpensive senior debt, through the accumulated profits generated by the business or through an acquisition of the company by a competitor. A mezzanine deal typically lasts for 5 to 8 years with most successful mezzanine deals resulting in an exit in year 3 or year 4. Early exits are successful transactions for mezzanine lenders and are usually achieved through a bank loan refinancing.

Advantages of mezzanine financing

Mezzanine financing can prove be extremely advantageous in several ways- especially for companies in the small and middle market sector that have moved beyond the start-up stage but yet do not have the capital to finance big growth moves themselves or the capacity to borrow through traditional lending arrangements. Such companies can benefit from

  • A higher amount of funding: With a mezzanine deal,a company can raise its total debt to three to four times its cash flow as when compared to senior secured debt.
  • The ability to retain control of the company or its direction: Owing to the relatively small percentage of equity involved, mezzanine deals do not affect ownership or management.
  • Highly flexible structures: Mezzanine deals offer customized solutions to structure coupon, amortization and covenants that accommodate the specific cash flow requirements of the business.
  • Valuable strategic assistance: Mezzanine lenders are financially sophisticated and bring with them experience in developing strategies that can help maximize long-term value.

Attract Capital has 20+ years of experience in helping private companies access mezzanine funding directly from mezzanine lenders. With a proven process and a lender platform of over 100 mezzanine lenders, we can help provide quick sourcing solutions for your mezzanine financing needs.

Contact us today to speak to one of our advisors. We will be happy to provide a free consultation.