Mezzanine financing is a hybrid of debt and equity financing that gives the lender the right to convert to an equity interest in the company in case of default, generally after venture capital companies and other senior lenders are paid. Mezzanine financing tends to be completed with little due diligence on the part of the lender and little or no collateral on the part of the borrower. It is treated as equity on a company’s balance sheet.
Need for Mezzanine Finance
Mezzanine capital fills the gap between equity and senior debt in the capital structure of a company, which may arise due to discounting inventories, fixed assets and accounts receivable at a higher rate than before, for fear of them not realizing their value a high proportion of intangible assets in a balance sheet ceilings on debt that can be raised from a bank.
To raise mezzanine finance, a company must have a credible track record in the industry, consistent profitability, and a feasible plan for expansion through an initial public offering (IPO) or acquisition. Thus, mezzanine finance is used by companies that have a positive cash flow.
Maturity and Redemption:
Mezzanine debt usually has a maturity period of 5 years or more. However, if the mezzanine debt is issued at the same time as bank debt, the mezzanine debt matures after the bank debt. Furthermore, given the high RoR offered on mezzanine finance vis-à-vis traditional finance, issuers often prefer shorter maturities. Mandatory redemption/prepayment is required in the event of asset sales or a change in control transactions.
Lenders that review mezzanine financing requests closely examine several facets of the prospective borrower’s business when weighing the deal. The most important consideration examined by a mezzanine lender is the company’s capacity to generate cash flow, if it is anticipated that the business’ cash flow is sufficient to repay the loan, it is quite likely subordinated debt can be used. In addition to cash flow, lenders also examine ownership flexibility, company history, growth strategy, and acquisition targets.