Mezzanine financing, also sometimes referred to as subordinated debt or financing, is a rarely used but viable financing option for small businesses in search of capital for rapid growth.
Subordinated debt is an extremely flexible form of financing.Because they are more concerned than senior lenders about their overall yield, mezzanine lenders are very liberal in tailoring their investment to meet the financial, operating, and long-term cash flow needs of the borrower.
Business experts point to mezzanine financing as a particularly provocative financing option for some companies that have moved beyond start-up status but do not yet have the wherewithal to finance big growth moves themselves or via traditional lending arrangements.
# Mezzanine financing is more expensive than traditional or senior debt arrangements.
HOW MEZZANINE FINANCING WORKS
In a mezzanine financing arrangement, the borrower negotiates an arrangement with a lender wherein the necessary capital is secured by combining a loan with a stock purchase to the lender.
The most important consideration examined by a mezzanine lender is the company’s capacity to generate cash flow. The primary concern of a subordinated lender is a company’s ability to generate cash, if it is anticipated that the business’ cash flow is sufficient to repay the loan, it is quite likely subordinated debt can be used. In addition to cash flow, lenders also examine ownership flexibility, company history, growth strategy, and acquisition targets.
Mezzanine lending includes both subordinated debt and equity component. The debt is issued with a cash pay interest rate of 12-12.5% and a maturity ranging from five to seven years. The remainder of the required 18-20% all in retuurn consists of warranties to buy common stock, which investor values based on the company, or incremental interest paid on a “pay-in-kind” PIK basis. The fee for raising the money runs between two and three per cent of the transaction.