The world of finance is wide open for all to explore and earn any amount to fulfil one’s delight and dreams of life. The more a person reads, becomes financially literate, higher will be the chances of the person of leading a financially abundant life.
In this domain of financial literacy, not so known the concept of mezzanine loans or financing is noteworthy. Mezzanine financing or loans are a hybrid type of loans that convert the debt of the borrower company into equity holdings. In case of lending, made for real estate processes, these the property automatically becomes the collateral for the transaction.
In the mid-way of private equity and proper loan financing, this type of loan enables big companies and real estate developers to borrow easily for a short duration of time.
Where is Mezzanine Finance Used?
In general, mezzanine loans are for those commercial deals that are complicated. At the same time, such financing sources are useful in the development of small businesses and their success. However, they should have a grown reputation and an effective business strategy.
Apart from the property, the lenders offer mezzanine loan by accepting the company’s shares in the form of collateral. It is a type of investment that lender spends. As the company sees growth, it expects a better return on its investment. It is the reason why it is called ‘senior debt’ especially to other lending options like the bridge loan.
The company can also apply for mezzanine loans to spend on significant projects.
Is Mezzanine Loan different from Bridging Loan?
Many financial experts are in the view that both the mezzanine loan and bridge loan are different from each other. However, they have a similarity in their availability for small business and ventures. Both belong to the small financing to the entrepreneurs. Simultaneously, they have some differences too that are describing below:
|Mezzanine Finance||Bridging Finance|
|It is an unsecured loan where no physical collateral is applicable.||The borrower has to provide collateral like property or inventory to avail bridge loan.|
|In the mezzanine, the lender reserves the right to possess equity shares in the company where it lends money if it does not repay.||Here, if the primary borrower or entrepreneur is not able to repay the money on time, then the lender takes possession of the collateral given.|
|The mezzanine loan may take months to process. Therefore, they are not ideal for quick financing.||You can apply for bridging loan through online. Instant funding access is well a possibility here.|
|The company can use the borrowed money for a larger project.||This loan is primarily useful for covering the short-term expenses of the company.|
|The rates of interest are relatively higher than other debts.||Since backed up the collateral, the interest rates in bridging loan are lower.|
RATE OF INTEREST
The rate of interest for this kind of financing is a bit expensive than other forms of debt. This is the primary reason due to which only major conglomerates can afford its servicing.
The rates of interest can vary from 12% to even 20%.
Adding to this, options for the fixed and variable type of interest is available for the borrowers.
TYPES OF MEZZANINE DEBTS
The types of debt offered by mezzanine financing would include:
- junior debt,
- preferred debt,
- convertible debt, and
- Participating debt.
All these types assist in funding in terms of preference for repayment.
Mostly convertible debts are very popular as it offers the option to gain equity in a company.
As this debt is only an additional type of unsecured debt, in times of a company’s liquidation, this debt is paid after other secured ones only. The lender lends against a stake in the company’s ownership. Mezzanine funding is for the short term fund requirements of large groups.
Besides, you can refer it as intermediate funding between equity and debt; these are the unsecured source of funds for real estate deals, leveraged and management buyouts.
A prominent real estate developer after borrowing a significant portion of the debt in the form of a typical loan will resort to this mezzanine funding for an additional monetary cushion.
- REAL ESTATE FUNDING
In real estate transactions, the default in the repayment of the debt qualifies the lending company to take hold of the ownership and rights on the respective property. It has the preference only after the first mortgage. Therefore it is also called as junior debt.
The lending company solely enables this funding after carefully ascertaining the market value of the property in question. Once, the market value is termed as useful to go, and then the lending process completes swiftly.
BENEFITS OF MEZZANINE FINANCING
Below mentioned are some benefits of mezzanine financing:
- NO DETAILED DUE DILIGENCE
The mandate of normal and detailed due diligence is negated in the case of mezzanine financing. Lending companies agree about the creditworthiness and profitability of the borrowing companies.
- NO COLLATERAL
Apart from the real estate transactions, in which property is the collateral till the time the entire loan amount to pay off. There are no compulsory requirements for any collateral, and the whole financing is done quickly without much hassle.
It is why it is an unsecured form of credit, and most prominent real estate players preferred it.
Once the mezzanine financing is done, the repayment preference is after other forms of secured debt only after real estate mortgage and different types of secured debts. It becomes an attractive feature for various companies to borrow for near term financing.
Because of this reason, this mezzanine funding is also termed as subordinated debt transaction, especially at times of business liquidation.
- LOW LEVERAGE LEVELS
As major companies offering this finance do so only after other types of financing are not there, the chances of reliance on leverage are less. The percentage of debt for the entire property investment for a real estate developer is less. It brings about a higher return on equity.
Dependence on the large portion of leverage in any transaction will mean mentioning of debts in the balance sheet, less confidence of the equity holders and mass public on the company.
Therefore, this finance does not enable high levels of leverage dependability.
- NO DILUTION OF EQUITY
Only when a borrowing company defaults in repayment, then the instance of dilution of equity or property getting attached arises. The possibility of significant loan defaults is very meagre here, and thus companies need not worry about losing control and ownership of the company.
- TAXATION BENEFITS
Additionally, mezzanine funding also enables a person to get a taxation advantage for the interest payments duly made.
In the Nutshell
Many people ask a question that mezzanine loans are safe to use or not. However, there is a bitter reality that no funding option is more reliable, as each of them is risky if borrowers do not utilise this sincerely. With these loans, you have the advantage of getting adequate funding without pledging any collateral. While there are disadvantages too like:
- Higher interest rates
- Lenders take shares of your company in case of no repayment
- Chance of being trapped in more debts
- You may lose the control from your business
Therefore, we would suggest you research a lot before going for mezzanine loans. Analyse your company’s capacity and most urgent needs. Once you do that and then move forward to apply for this financing.