For a middle market business, mezzanine debt is often the easiest and safest way to fund a future transaction, whether it is an acquisition, buyout, refinancing of debt, or just for growth. Often, the loan is long-term with an 5 to 7 year maturity dates, which gives the company breathing room and a valuable transition time to invest in its future. A mezzanine loan is a deal between a company and a mezzanine lender. It is a trade based on mutual comparative advantage as the lender receives certain benefits and the company receives valuable capital availability.
Mezzanine debt investors create loans based on cash flow. The lender realizes the potential in long-term growth of the company and therefore, focuses on ensuring the generation of cash flow to pay back the principal. If the company cannot generate enough cash flow to satisfy the debt service requirements of the mezzanine debt investor, they will pass on the deal. Mezzanine lenders often look for a certain rate of return that can come from cash interest, PIK interest, or ownership. Cash interest is a periodic payment of cash based on a percentage of the outstanding balance of the mezzanine debt. PIK, or payable in kind, interest is a periodic form of payment in which the interest payment is not paid in cash, but rather, by increasing the principal amount by the amount of interest. Some mezzanine debt transaction will involve an equity stake in the form of attached warrants or a conversion feature that is similar to that of a convertible bond. Either cash or PIK interest almost always accompanies the ownership component in mezzanine debt.
Mezzanine is risk capital and depends on the long-term cash flow and EBITDA, or earnings before interest, taxes, depreciation, and amortization, of the business. If the planned growth of the company is achieved, mezzanine financing will be repaid on time and the business will have no trouble fulfilling the interest payments as well. No matter how you want to use mezzanine funding, it will always provide great value money for a business. There is no personal guarantee and the principal repayment is deferred for several years.
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