What are the risks to be aware of with mezzanine products?

The risks to be aware of with mezzanine products

Mezzanine financing is defined as cash flow based loans that are highly customizable and best used in conjunction with mergers and acquisitions. Mezzanine lending products are driven by a Company’s EBITDA. A mezzanine financing opportunity arises when the banks can no longer stretch further into the capital structure to fund a deal. There are several risks to be aware of when receiving a mezzanine loan. Firstly, the company needs to ensure that its cash flow is strong enough to cover the debt service and the additional upside required with such a loan. Often, companies do not adequately estimate the amount of up front fees or the size of the warrant take out when projecting their cash flow. Secondly, a mezzanine loan is expensive capital in its own right and needs to be paired with lower cost bank loans to deliver a workable weighted average cost of capital. When determining the total debt capacity of the firm, it is advisable to include the average projected outstanding under the line of credit. Thirdly, the balance sheet of the company will have more loans with a new mezzanine loan. You should consider the optimal level of leverage for your business and your industry before bringing in more loans through a mezzanine raise. Finally, mezzanine financing is best used as a transition capital solution and needs to taken out within a few years, lest it become to expensive to service. With proper advice and representation, mezzanine financing can be a strong option for a company as long as downside risks are mitigated.

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