There are three main types of business financing; debt funding, equity fundraising and mezzanine finance. Although most business-related finance tends not to be in the form of ‘traditional’ secured loans, it is possible to add collateral to a business loan, for example by remortgaging a property.
Debt funding is the most common form of borrowing money, where you receive money and pay it back at an agreed rate of interest. Equity fundraising is offering a portion of your business in exchange for funding. Mezzanine finance is slightly more complicated and often looks like a mixture of the two other ways of fundraising.
What Is Mezzanine Finance?
Mezzanine finance is a form of property financing, and can be used in a range of scenarios. This form of financing is most commonly used when the party looking to purchase the property is not able to gather all the funds needed using either debt funding or equity fundraising.
The loan is originally offered as cash and then part of it transforms into equity at a predetermined time agreed by both parties. Effectively, the company borrowing is using the equity in order to secure a loan.
Mezzanine Funding and Commercial Real Estate
Mezzanine financing is often used to fund commercial property deals, because the property itself can be used as equity. For property developers, mezzanine financing can be used to facilitate significant financial deals by placing the Investment property itself as the collateral.
With deals like this, the terms usually last for between 1 and 5-years, although it can be longer. Loans of this type are usually fast-tracked because the property value gives lenders immediate security.
Typical interest rates for a mezzanine finance deal is between 10 and 30%. Higher interest rates might be linked to the level of equity being offered in lieu of cash. These higher rates of interest reflect the risk for the bank relating to these deals. Mezzanine funding is preferable for large, profitable deals where this high percentage of interest is still worthwhile.
What Are the Advantages?
Mezzanine finance, much like any other form of finance comes with a host of advantages and disadvantages that anyone considering this form of finance should be aware of (source: Kallyss.com) in advance to submitting an application:
Immediate – access to the capital you need
Equity – Borrowing against equity means that – as long as the deal goes to plan – you will retain your equity, compared with equity finance
Tax deductible – In some cases, interest on payments can be tax deductible
What are the Drawbacks?
All loans and financial arrangement come with potential risks and mezzanine finance is no different:
Loss of control – In cases like this, terms and conditions can be very detailed and there can be very specific criteria that the borrower must adhere to
Debt and equity – If things do not go as planned your company will end up in debt or giving up equity as interest to your lenders
What Happens With Mezzanine Financing And Liquidation?
If your company goes into liquidation while you still owe money on your mezzanine financing, this loan will be paid off after any other debts that the company has.
Lenders provide mezzanine finance as a second charge or subordinated loan. This means that any first charge loans will be paid off before the lender of the mezzanine financing.
This is the reason the interest rates are often much higher with mezzanine financing. There is more risk for the lender which often means higher interest rates for the borrower.
What Are The Lending Criteria For Mezzanine Financing?
In order to secure mezzanine financing you must meet the following criteria and understand these key points.
- Mezzanine financing is secured by a second charge
- The financing will require full planning consent
- It is available for both residential and commercial real estate developments in England, Scotland or Wales
- Mezzanine financing will only be an option for experienced property developments with a proven track record of success
- You will be required to provide a personal guarantee document
Whenever you are looking into financing a new business opportunity or to borrow money as a company it is wise to consult a financial expert. Financial experts will be able to recommend the best type of financing for you, explain your options clearly and advise you how to secure the funding you need.