Checklist Description
This checklist outlines when and how to use mezzanine financing.
Definition
Mezzanine financing can be an ideal solution for firms looking for a quick injection of capital to grow their already successful business without giving up an interest in that business.
Mezzanine financing presents a way for publicly and privately held companies to obtain financing without ownership of the company being given up. It is a mixture of traditional debt financing and equity financing that offers the benefits of both. Mezzanine financing, like equity financing, is an unsecured debt that requires no collateral, unlike a traditional bank loan. Like debt financing, mezzanine financing is very flexible and does not necessarily involve giving up an interest in the company. Likely sources of mezzanine financing are private investors, insurance companies, mutual funds, pension funds, and banks.
Because mezzanine financing is normally provided very quickly, with little due diligence by the lender and with little or no collateral required from the borrower, this type of financing tends to be expensive, with the lender seeking a return of between 20% and 30%. Mezzanine financing also has the advantage that it is treated like equity on a company’s balance sheet, which may make it easier to obtain standard bank financing.
To attract mezzanine financing, a company usually must demonstrate:
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A track record in the industry, with an established reputation and product.
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A history of profitability, or at least of breaking even.
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A viable expansion plan for the business through acquisition, broader penetration of the market, etc.
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Solid management and operations planning.
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An established business plan.
In leveraged buyouts, mezzanine capital is often used in conjunction with other securities to fund the purchase price of the company that is being acquired. Typically, mezzanine capital will be used to fill a financing gap between less expensive forms of financing (senior loans, second-lien loans, high-yield financing) and equity.
Due to the lack of valid collateral, as well as the high speed of lending, mezzanine financing is typically more difficult to obtain than a traditional bank loan or equity financing. However, the benefits are that mezzanine financiers do not normally interfere in company management and, except in the case of a default, they do not want an interest in the company. Whereas traditional equity investors may attempt to gain some level of company control, mezzanine financiers will do what they can to ensure that the debt is paid off without resorting to default.
Advantages
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Mezzanine financing often offers more flexible financing options, such as coupons and covenants that take into account the business’s cash flow.
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Mezzanine financing provides business owners with the funds they may need to buy another business or to expand.
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Little or no due diligence and collateral.
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Generally no loss of ownership control.
Disadvantages
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Mezzanine financing is normally aggressively priced, with lenders seeking returns of between 20% and 30%.
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Financiers can include restrictive covenants that the borrower has to endure. These can include agreements by the lender not to borrow more money or refinance senior debt from traditional loans.
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Financiers might want to have a vote on the board of directors.
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Many financial experts believe that this type of financing has aggravated the recent credit crunch.
Action Checklist
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What other avenues of financing are available that would not load the company with so much debt?
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In return for the loan, does the company have to cede some independence to the lender?
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Does the loan restrict the company to spending money in certain areas?
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Does your company have a strong market position based on its products/technology and a market share that will allow it to repay the loan?
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Does your company have a focused business strategy and positive long-term development prospects?
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Do you have positive, stable cash flows that can be forecasted reliably?
Dos and Don’ts
Do
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Check that the possibilities for funding from other resources have been exhausted or are insufficient.
Don’t
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Don’t use mezzanine financing if there are serious underlying business problems that need to be addressed.
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