At some point in every business, there is a need to find additional financing. There are many options for financing, from traditional loans to venture capitalists. You need to figure out what option works best for your business. One type of funding to consider is mezzanine financing.
Often used in conjunction with a senior loan issued at the same time, according to Inc.com, mezzanine financing is a deeply subordinated loan which may be structured to allow the lender to acquire equity in the business. It is a risky type of loan for lenders because it ranks just above equity of the business owners. Adding to the risk is the fact mezz loans are secured by a junior lien or, sometimes, are completely unsecured.
To get this type of financing, you need to have a profitable business, typically with an enterprise value of $10 million or more. It is not available for start-ups and smaller businesses because they lack history of successful profits and sufficient cash flow to support a tiered loan structure. A mezzanine lender often wants to see that your business has a stable position within its market. Essentially, you need to prove that your enterprise is a good risk that will pay back the loan.
Mezzanine financing will typically bear a high interest rate, so it will cost more than a senior loan. However, it offers flexibility in conditions and terms that are not available with a senior secured loan. Plus, it is a good alternative to another equity round that can preserve upside for equity holders over time.
There is always a risk. If you have a downturn in business, the mezzanine lender may exercise its right to own equity and dilute ownership. It is possible for majority owners to lose control of the business when a lender exercises its equity rights, depending on how the mezzanine loan is structured. Furthermore, the lender is likely to restrict the company’s ability to borrow more money and to put strict standards on business financial ratios. The lender will generally also place limits on the ways the loan proceeds can be spent.