Why Entrepreneurs Embrace Mezzanine Debt

Posted on: February 18th, 2020

The Classic definition of an entrepreneur is someone that can do a lot with a little. Driven by innovation and vision, entrepreneurs seek to scale their companies rapidly. Rapid scale ups require outside capital and increasingly entrepreneurs are keen to raise mezzanine debt due to fund their growth. Mezzanine debt offers several unique benefits that resonate with entrepreneurs, particularly more capital, more relaxed principal repayment and bespoke, flexible structures. The uniqueness of mezzanine debt as a hybrid type loan incorporating the best elements of both equity and a loan, is increasingly being recognized by entrepreneurs. Mezzanine is a great form of capital to fund a high growth transitional period of entrepreneurial growth.

Why Is Mezzanine Debt a Hybrid Type Loan?

As a hybrid type loan – mezzanine debt combines the best features of the two layers of capital it resides between – a bank loan and an equity investment. It has the long-term view and valuation approach of equity, giving it a high level of versatility in addressing virtually any corporate capital need. It combines this with the structure of a loan, with a fixed interest rate and a mid-tier position in the capital structure for the lender. Working synergistically, these strengths allow a mezzanine lender to offer more capital than a traditional loan, at a far better price than an equity investment. Often this leads to mezzanine debt offering the best growth capital option for an entrepreneur.

How are Mezzanine Debt Loans Sized?

Rapid scale ups involve significant growth investment, often a sum far in excess of a company’s available cash or bank borrowing availability. Mezzanine debt approaches loan sizing on a cash flow multiple basis, resulting in much larger loan sizing. In fast growth situations, a company’s capital bandwidth is the key to success, as it enables a company to increase its staffing, capacity and regional presence. Mezzanine loans offer an entrepreneur the most amount of capital than any other loan in the market, by applying a multiple to your company’s EBITDA. Typically, the multiple is set at a level from 3 to 4 times. This sizing approach yields a much larger loan than any other loan offered in the market.

The Favorable Maturity and Repayment Profile of Mezzanine Debt

In addition to providing a larger loan amount, mezzanine debt loans offer longer terms and more relaxed repayment. Typically, the term is 5 to 6 years and no principal repayment are due until the maturity date. This favorable structure provides a huge cash flow benefit to a growing business, in that they can keep reinvesting their cash flow. Compounded cash flow reinvestment creates a virtuous cycle of growth investment which catalyzes long term growth potential of the business. Without the burden of repaying the loan right away, you can invest in long term growth projects that will sharply increase the overall value of the business. This relaxed approach to repayment gives the company more time, often the scarcest of commodities in fast scale-ups, to perform and realize its growth journey.

The Advantages of Mezzanine Debt over Raising Equity

Entrepreneurs don’t like to take equity because they want to own 100% of their companies. Equity is not only dilutive but also comes with a level of intrusiveness. Equity investors usually have a level of influence or control when they invest in a company. Entrepreneurs tend to resist this type of arrangement and prefer capital providers that are passive, who let them run the business and stay out of there way. Mezzanine debt providers may size their loans like equity investors, but they act like passive lenders, once in a deal. They are very pro management. If the company is performing and paying their interest, they usually leave the management team alone.  This level of freedom is very attractive to an entrepreneur. Mezzanine debt is less expensive than equity, and less difficult to manage, after the deal is closed.