Business Loans: Mezzanine Financing

alternative loan option

Mezzanine financing has some clear-cut parameters such as the following:

  • It is an alternative instrument for entrepreneurs, SMEs, etc. In that respect, it can even have the effect of a capital injection for a growing business;
  • It is not a substitute for other forms of company finance. It can even be used in combination with venture capital or business angel financing, etc;
  • No or little public involvement, usually targeted, is needed for its functioning. It occurs in the private capital market;
  • It is encouraged by policy makers to be used by SMEs;
  • Since the 2007 financial crisis, some countries have introduced it in order to support SMEs and entrepreneurs as an alternative finance;
  • An important reference to the instrument brings home the idea that traditional bank financing still stands as the best for SMEs business activities.

Although there is no universal definition of the term, the characteristics of mezzanine finance comprise more risk for the investor in comparison with a loan provider. It may involve participating or subordinated loans, as well as other forms. It may be combined with other techniques, and may be used for business expansion.

Usually, the appropriate mix of instruments is tailored according to the company’s needs and investors’ risk taking. The benefit of the latter is described as a “success fee”, according to which the investor receives a share of the company’s profit, as well as other forms of investor’s earnings like “silent” participation, equity “kicker”, etc.

Control acquisition is avoided, and investment and exit strategies for mezzanine financing entities are predominantly related to ensuring debt repayment. In that respect, regular information about the business development of the company, according to pre-fixed financial indicators, should be provided. SMEs respond to strict requirements related to their accounting and information policy line.

Unlisted SMEs are offered with a way to obtain capital via mezzanine financing. Treated as a “subordinated debt”, banks as traditional lenders accept it as an equity increase. The company’s credit rating may be improved when it enjoys a favourable proportion of equity to debt. SMEs backed by institutional investors are usually in a capacity to get credit under good terms. For the entrepreneurs, the reserve capital in parallel to basic finance, reduces dependence on a sole financial source, and contributes to support diversification.

An important aspect of mezzanine capital is that it is best suited for SMEs with a relevant growth profile, solid cash position, and needs financing at a certain life cycle of its business. Against this background, the company has to enjoy a good track record, sound reporting capabilities, an experienced management, stable flows for the sake of evaluation of risks, and drivers of growth.

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