What is mezzanine finance?

Understanding mezzanine finance

Mezzanine finance combines debt finance, where you repay a loan at an agreed interest rate, with equity finance, which involves diluting some of the ownership of your business by offering equity to the investor.

This type of business financing is commonly used to grow established businesses or to fund large projects. Mezzanine finance can also be useful in a management buyout scenario and for supporting property development projects.

When might mezzanine funding be used?

Mezzanine funding is typically an effective solution when a company cannot secure finance via a standard business loan, but where directors don’t want to go down the equity finance route and give away any control of their company.

With this form of finance, businesses may be able to obtain the higher level of financing that they need but as it’s a hybrid of debt and equity funding, if they’re unable to repay, the lender can receive an equity share in the business.

How does mezzanine finance work?

Mezzanine funding is provided as a business loan but the debt isn’t cleared in the ‘traditional’ way. Sometimes it’s repaid as a lump sum, but if the borrower cannot repay once the pre-agreed term comes to an end, the debt owed converts to a shareholding for the lender.

In other scenarios, profit sharing with the financier might combine with the interest payments to make another hybrid borrowing option. So what are the advantages and potential drawbacks of mezzanine financing?

Advantages and disadvantages of mezzanine finance

Advantages

• Tax-efficiency: interest payments are tax-deductible
• Higher levels of borrowing available: compared with traditional bank lending, mezzanine finance can offer businesses the opportunity to borrow more
• Less costly than equity finance: not having to offer equity in the business retains the desired corporate ownership and makes mezzanine finance less costly long-term
• Lower debt load: as it’s typically treated as equity on the balance sheet, this helps to control a company’s debt levels

Disadvantages

• More expensive than traditional debt finance: mezzanine finance is not as costly as equity finance but it is more expensive than standard bank loans
• Restrictions on further borrowing: mezzanine finance agreements can restrict a business’s right to borrow further, or to refinance an existing debt

Applying for mezzanine funding

Mezzanine funding is complex and it’s important to understand whether it’s right for your company. Our team at UK Business Finance can ensure you opt for the most suitable financing for your needs and will make an application on your behalf.

A mezzanine finance application will need to be supported by a range of financial documents, including three years of business bank statements and tax returns, information on any existing debt, your balance sheet and profit and loss statement, and a detailed business plan.

For more advice on mezzanine finance, please get in touch with one of the team. We’re an independent business finance brokerage with a wealth of experience industry-wide and offer a free, no-obligation service to our clients.