Most lenders prefer you have collateral to help secure a business loan, but if you do not have one you can opt for mezzanine financing which can allow you to get the loan you need without any collateral.
Mezzanine financing is a type of loan that uses the company’s shares as collateral. If you are unable to pay the loan, the lender converts the debt into an equity share of your company. When you work with mezzanine lenders, the contract that is signed says that the lender will receive an equity stake in the company if you do not pay your loan. If this happens the lender can sell that share as a public offering and recollect that debt.
Mezzanine financing is great for those businesses who are past the startup stage but do not have the funds to invest in their company. For growing companies with a strong cash flow, mezzanine financing may be the way to go.
How Mezzanine Financing Works
Although business owners can get capital quickly by getting a loan without putting up any collateral, it is high-risk financing due to the high interest rates. Mezzanine lending is commonly used in the expansion of established companies. It is great for companies that are expecting to go public, mergers and acquisitions, private equity buyouts, and real estate developments.
To qualify for mezzanine financing, a company needs to show that it has a strong track record in the industry and is well established with a good reputation. Mezzanine lenders will require you to have a profitable history so they can be confident to that you will pay back the funds. They also will require a detailed description of how the capital will be used to generate more income for the company.
Why Should You Use Mezzanine Financing?
Although there are high interest rates associated with mezzanine financing, there a few reasons to consider using it still.
- Mezzanine debt is treated like equity on your balance sheet, but the interest is tax-deductible.
- If you want to grow quickly but without giving up equity.
- Mezzanine loans can be used to pull equity out of your company.
- It allows you to improve your ROI and decrease your initial investment.
Advantages of Mezzanine Financing
There are several benefits to considering mezzanine financing for your business. They include the following:
- The flexibility it gives borrowers and lenders
- Borrowers can count on paying a fixed interest rate during the term of the loan
- A lower cost alternative to raising equity or selling shares to an investor
- This financing gives higher amounts of funding than a bank loan or asset-based loan
- Mezzanine financing lenders collect their payments on a monthly, quarterly, or yearly basis
Disadvantages of Mezzanine Financing
- Owners sacrifice control due to loss of equity
- Owners pay more in interest the longer mezzanine financing is in place
- Lenders are at risk of losing their investment in the event of bankruptcy
The Bottom Line
Mezzanine financing is a loan that is structured like a debt and equity. Mezzanine funds are lent against company stock or an ownership interest rather than real property. In the case that the borrower defaults on the loan, the lender can covert the loan into ownership in the company. There is a higher risk associated with a Mezzanine loan but it will be worthwhile in the end.