Mezzanine debt and/or Mezzanine Financing provides a way for public and private companies to obtain financing without going public and potentially taking hold of their company. It can be considered as a mixture of traditional debt financing and equity financing that enjoys the benefits of both. It is an option for companies to get funds through equity financing and a hybrid of debt. Like equity financing, mezzanine financing is an unsecured loan that does not require the payment of deposit, unlike traditional bank loans.
Mezzanine debt arises when a hybrid debt outflow is subject to another debt issue from the same issuer. This type of debt has commonly attached to equity instruments, commonly known as warrants that increase the value of quasi-debt and provide broader flexibility. This debt is highly relevant with buyouts and acquisitions that give the priority to the new owners when there is bankruptcy or total failure of the companies
Another definition of mezzanine debt is the provision of resources for the needs that you cannot predict when the initiative moves forward and the company gets bigger. Venture capital companies can provide financing to companies through convertible bonds and share pledges. However, if a company fails to pay the debt it has received, the lender may exercise its right to become a shareholder of this company. Therefore, this type of financing can be seen as risky at the same time.
This type of financing relies on very high-interest rates in the 20-30% range to make it profitable. Unlike a bank loan, Mezzanine Debt does not hold a company’s real assets as a deposit; instead, lenders offering this debt have the right to convert their shares into equity or ownership rights in the event of a default of debt.
Advantages of Mezzanine Debt
What is the advantage of mezzanine debt question is frequently asking. It can be said in its shortest form that it is a particularly attractive form of liquidity for owners of privately owned companies. Traditionally, it appears that a privately owned company can not provide the same type of liquid capital flow as a public company, but mezzanine financing offers a way to offset this situation without going public. It is also an important point that financiers do not want to show interest in the company actively, in addition to the fact that they are not interested in the company except in cases of default. Another advantage of this financing is the tax-deductible interest which is very crucial for company holders. In accordance with the balance of the loan, borrowers arrange their interest. This type of flexibility and manageable structure makes mezzanine debt highly attractive for the companies.
Disadvantages of Mezzanine Debt
Due to the lack of real deposits and the high lending rate, mezzanine financing is more difficult than a traditional bank loan or equity financing. A company must have an established track record in its industry, show a real profit or at least show it without loss, and have a strong and applicable business plan for future expansion. Because of these limitations, this type of financing is not suitable and preferable for every business. For businesses looking to get quick capital attainment to grow their already successful business, without giving up interest payments, mezzanine debt can be an ideal solution.