Understanding Mezzanine Financing

Published date04 October 2022
Subject MatterFinance and Banking, Corporate/Commercial Law, Financial Services, Corporate and Company Law
Law FirmAmini & Conant
AuthorAmini & Conant

Mezzanine financing blends equity and debt, with lenders providing subordination loans over traditional ones. When a business needs funding for a significant acquisition or project, creative financing options like mezzanine loans can help to fill that need. Understanding mezzanine financing can be difficult since it differs slightly from traditional loans.

What Is Mezzanine Financing?

This financing level is a capital resource between the less risky senior debt and the more risky equity. Mezzanine financing is a type of junior capital with equity and debt features. Many companies use mezzanine financing to reach funding goals that traditional lenders will not extend. Often, established companies want to preserve their future senior debt capacity or have already maximized their borrowing capacity. Mezzanine financing is the last stop in the capital structure where companies can raise large amounts of liquidity without selling a substantial stake in the business.

Mezzanine-level financing can take the structure of subordinated debt, preferred stock, or convertible bonds. Sometimes, these loans may offer participation rights to the common equity, which is less dilutive than other types of equity. While mezzanine loans are more expensive to borrow than typical senior debt, they carry a longer term until their final maturity, typically seven to eight years. Also, these loans are interest-only with no amortization before the maturity date. With these favorable terms, businesses can have more time to process shareholder activity and can build their senior capacity, which may help with refinancing the mezzanine capital over time. Mezzanine finance options are not considered a permanent solution to capital. Instead, these terms are for solution-oriented capital that serves a particular interest of the company. Later, other types of cost capital may replace the mezzanine level loan.

Subordinated Debt and Preferred Equity

Subordinated debt is an unsecured loan or bond that ranks below senior securities and loans. In the case of borrower default, the subordinated debt holder must wait while the senior debt holders receive their payments after foreclosing under Article 9 of the Uniform Commercial Code (UCC), according to the American Bar Association. The company promises to pay all unsecured subordinated debt when there is no credit or liens that can support it. However, businesses can secure mezzanine debt with a lien on the underlying property. These payments are...

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