Mezzanine Finance

Mezzanine finance provides unique opportunities for businesses and property developers, combining traditional debt [a loan] and business equity. It is a hybrid offering in which a traditional loan is cleverly combined with equity in a similar way to an investor. However, the difference is that the amount of equity on offer is less than would be required for say a Venture Capital investor.

This type of finance tends to be utilised in cases where there is a higher degree of risk involved with the lending, but potential return is very large. It is the potential of increased return that allows lenders to provide the funds applied for by the business in question.

These loans can also be well utilised to ‘top-up’ existing secured property finance, for example bridging loans, to provide that extra bit of funding that could mean significant business expansion

How Does Mezzanine Finance Work?

In normal circumstances, when a lender provides a loan to a business, there will be an agreed amount determined and then lent over a predetermined time frame over which time the borrower will repay the loan amount plus interest and it is the interest that provides the lender with their return.

When it comes to equity investors, they will pledge an amount of money to the business requiring funding in return for a percentage stake in the company, having assessed the growth and profit potential of a business. It is the success of the business over time that provides their return in these cases. The investor may either receive share profits from the business or they may sell of their shares at a profit.

Mezzanine finance though, tends to be secured as a second charge loan on a property and can be useful for property investors that need that bit extra to push ahead their business in a way that may otherwise be impossible. When it comes to this type of finance it is important that you have a tried and trusted team on hand to ensure that you can secure the best loan available on the market.

With mezzanine loans, the lender will provide the funding the borrowing business requires. However, there will also be a clause in the agreement that if the loan is not repaid within the agreed timeframe, the lender receives equity in the business to act as repayment for the outstanding loan and interest amount.

The Benefits

With regards to repayments, mezzanine finance is repaid on an annual rather than a monthly basis. This means that the borrower can focus on expanding and running their successful business from the outset rather than having to immediately worry about repaying a loan.

When is Mezzanine Funding Useful?

These loans are suitable for cases where other loan avenues have been exhausted and other funding routes are not available or potential investors who see the potential in a business require too high a percentage of equity.

Topping Up a Loan – A developer may have a first charge loan on a property, for example a mortgage or development finance arrangement but needs a bit extra to further develop the property in question to increase its yield. For example, a developer has a first charge loan of £600,000 on a property worth £1,000,000 and needs £100,000 more to be able to complete the development. A lender may offer 50% of the amount required via a loan, then require 25% in equity with the borrower having to source the remaining 25%.

High Risk Ventures – A potentially lucrative business venture may be deemed too high risk for lenders and the borrower may not be able to afford the loan repayments. Rather than simply rejecting the borrower, a lender may offer mezzanine finance which would provide them with equity in the business. Because the business has huge potential, the lender may be willing to take the increased risk in return for a share of potentially large future profits.

How Mezzanine Finance Providers Lend

As with all other secured property finance, the terms of contract will be clearly determined prior to any loan being provided. The mezzanine loan will tend to be treated akin to a normal ‘debt’ in that there will be a defined period, for example 12 months in which time the borrower can repay the loan. Then, once the agreed period elapses, if the borrower hasn’t cleared their debt or perhaps deferred the interest payments and made some headway, the lender triggers a clause in the contract that awards them an agreed percentage of equity in the business acting in place of repayment.

The Benefits of Giving up Equity

These loans, require relinquishing a percentage of equity and mean that should the borrower be unable to repay the loan, they will have to give up some equity but a big advantage is that they will not be burdened with debt as would otherwise be the case. They allow high potential businesses to secure funding they may otherwise be unable to acquire due to the increased risk of their ventures.

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