Mezzanine capital combines loans and shares from investors, providing quick financing for small businesses. If the loan cannot be repaid, the lender gains equity. Mezzanine capital can improve a business’s balance sheet and attract other forms of financing.
Mezzanine capital is a type of financing plan for a business that combines loans from investors with shares offered to those same investors. The general idea behind it is that the firm will pay the lender back in equity if it is unable to repay the lender in equity. For a business, mezzanine capital is a way to get quick and substantial financing and improve its balance sheet. Investors in this deal benefit if the business grows because they will get either repayment of the loan with interest or growth in the value of their shares.
Lending money is often a necessary process for small businesses that may initially lack the capital to compete with well-established forces in the marketplace. Unfortunately, lending options for such fledgling businesses are often limited, as they may not have the proven track record to attract significant capital from banks and are not large enough to go public on the open market. For such small businesses, mezzanine capital is one viable way to raise the money they need to grow.
The basic structure of the mezzanine equity deal is a simple loan from some investment entity to a business. Such loans are usually secured even if no collateral is offered and without the business having a proven track record of earnings to prove its long-term value to investors. Since this is the case, the interest rates offered to the lender upon repayment are significantly higher than what an established business might be able to offer.
If the company is unable to repay the loan, the lender is repaid with the company’s equity in the form of preferred stock, which essentially gives the lender an ownership stake in the company. The mezzanine equity loan is generally subordinated to other business loans, which means that the business will only begin repaying it after its senior debt, such as the bank loan, has been repaid. That said, there is a distinct possibility that the lender will gain equity.
Another advantage of mezzanine capital is that the company can include it in its balance sheet, thus making the business more attractive to investors and thus opening up the possibility for other forms of financing. The firm usually regains control over operational decisions, although lenders may have a say depending on how much equity in the firm they gain from the deal. This equity is attractive to investors, as they may have the opportunity to cash in on their shares if the business becomes a bigger factor in the market at some point in the future.
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