Mezzanine Debt Financing is a hybrid form of financing, provided by funds for acquisitions, growth or buy-outs. While structured as a loan, mezzanine debt is a close cousin of equity investment. Often, it can be used as an equity investment substitute. This is a great thing for a business owner because swapping equity for mezzanine debt is a great low cost trade. With an equity investment, a business has to give us a lot of shares and often has to give up a controlling interest in the company. With mezzanine debt, a business has to pay an interest rate of 12% and provide the lender with additional return through a warrant kicker.
If the company can afford to pay the 12% on a current basis, it mitigates having to give up a large ownership stake to an equity investor. Equity investors have to achieve high returns and take a lot of shares because they are the last ones paid out of the company. Their returns are generally in the 20% to 30% range. Mezzanine lenders are in a better ranking position than equity investors and are usually beneath the bank but ahead of the equity investors. Because, they are in the middle and not at the bottom, they have lower risk than an equity investor and consequently charge less. In fact, most of the return consists of the interest payment. Mezzanine debt financing has become a large pool of capital in the financial markets.
There are several hundred mezzanine funds in the US alone and their aggregated capital is in excess of $10 billion. Mezzanine debt financing is a great low cost way to build long term value. It can be used to fund an acquisition, a buy-out, a new growth phases and a cash out payment to the owner. The key to a successful mezzanine debt financing is the right structure and presentation.
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