Companies need funding to grow at a rapid rate. Growing companies require more capital than they think they need, due to the paradox of growth. Growth creates the need to finance higher levels of working capital as well as higher levels of staffing and overhead. Often, business plans fall short in estimating the amount of capital needed, and the amount of financing a bank will give you.
10 years ago, banks had a full range of loan products ranging from lines of credit to cash flow term loans. Nowadays, due to regulatory changes in the banking industry, banks really only offer asset based loans. Long term growth needs to be funded with long term capital, yet bank loans generally are only 1 to 3 year terms. Smart corporate finance planning requires an alternative to bank funding, to make sure the company can fill the growth gap.
Mezzanine funding has long been a great way for a company to raise growth capital, as a complement to their bank loan. The essence of mezzanine is that it sits beneath the bank loan on the balance sheet in second position and relies upon future cash flow for principal repayment.
It is provided for transitional capital events that a company may have where they need more money than they can produce internally. The annual interest rate is about 12% for mezzanine which means it is expensive money. Due to the price of the money, it needs to be synced up with a high return project in order for a mezzanine raise to make sense.
If mezzanine financing can help you double the size of the company through an acquisition, it is a great move. Mezzanine can help you clean up some old accounts payable or to expand your operational capacity so you can grow faster. In banking circles, mezzanine is a considered a form of inexpensive equity, which is non-dilutive and non-intrusive. It works well for companies that have strong management teams and strong financial reporting, that want to fund acquisitions and do not want to bring in an investor.
Increasingly, due to bank’s shrinking appetite for risk, mezzanine is used in lieu of bank loans, as a direct lending alternative. Mezzanine is infinitely more flexible and more valuable to a company than a bank loan. While it costs more, it is worth more, which explains its popularity on the lending scene.