Is Mezzanine Financing
 An Option For Your Business?

As the term would imply, mezzanine financing is an intermediate financing facility that falls between senior debt and senior equity. It is predominantly designed for larger businesses, but has been a growing financing source for mid sized companies.

The growth in popularity from both the lender and investors point of view is due to the increasing difficulties mid sized companies continue to have in acquiring capital from senior debt lenders like the major banks, and public equity sources like IPO’s.

To be more specific, mezzanine (also referred to as Mezz) financing is primarily debt that is subordinate to a senior debt lender, but which commonly carries some equity participation being some combination of shares, warrants, options, etc.

Growing companies that cannot increase their debt financing with senior lenders are looking more and more to a mezz finance alternative.

This source of financing has several advantages.

First, because it’s subordinate to senior debt, the borrower is leveraging existing and future cash flows to secure the financing instead of just being able to leverage assets.

Second, even though there is a more expensive cost of financing compared to senior debt, it will be a considerably lower cost than equity, and can potentially be repaid over time.

Third, when an equity participation element is in place, the mezzanine amount can be considered equity on the balance sheet, strengthening it in the process and even potentially making it easier to secure standard bank financing.

From the lender’s point of view, the lender’s security position, while behind the senior lender, is ahead of equity investors and shareholders in the event of business default.

The primary disadvantage is that the cost of borrowing is higher and can leave very little margin of error for the business for a number of years until the debt is paid down.

In addition, some tightly held companies are reluctant to consider mezzanine finance because likely will require them to relinquish some amount of ownership. At the same time, mezzanine lenders in many cases are not interested in long term ownership, but include an ownership interest in the structure of the deal to increase their potential return and manage their risk.

Sources of Mezzanine Financing Continue To Grow

Due largely to the success institutional investors have had investing in private companies, there continues to be a growing interest in the Mezzanine Finance Market.

Well established companies with strong management in growing industries where strong potential exists for future exit strategies (IPO, mergers, etc.) are viewed to be strong candidates for mezzanine finance.

While the industry is growing, participants are still very selective as to what they are prepared to fund.

Mezzanine finance is not typically an option for smaller companies due to the fact that smaller businesses are still trying to establish either their market or their market position.

In Canada, the market lags behind the U.S., but is expected to continue to grow in the years to come as private firm investing opportunities continue to be some of the stronger potential investments for pension funds and private investor groups that are looking to both increase their returns and reduce their overall portfolio risk.

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