What Sets Mezzanine Financing Apart From Regular Loans?
When looking at what financing options are available to expand your business or make a commercial real estate investment, you may come across the concept of mezzanine financing. This kind if financing is similar to regular loans, but there are significant differences. Mezzanine loans are a combination of debt and equity, and the lender can have some control over the company if the debt isn’t paid by taking a part of the stock. Mezzanine loans carry a high risk but can produce ample rewards and provide an option for seasoned companies to continue to grow.
How Mezzanine Financing Works
Mezzanine financing tends to be less than the primary loan, and its purpose is usually to fill the gap between how much the bank wants to lend and the amount of capital the borrower is willing to commit for the project or investment. Mezzanine loans tend to have high interest rates and short periods of repayment. The lender is paid back only after the main lender is compensated if there is a foreclosure, but with a warranty, the mezzanine lender can translate debt into equity and take some of the company’s stock.
Terms and repayment
The terms and repayment schedule for mezzanine loans can be more flexible than regular loans, but the lender is given input in the running of the company and can impose some restrictions, such as the amount of money the company can borrow or what to do with assets. Some business owners and investors might find this restrictive and burdensome, but others welcome the input of the mezzanine lender, especially since the firm has equity in the company and it is in the interest of the lender to see the company succeed. Some companies welcome the counsel of a seasoned mezzanine lender, especially if the firm has a proven track record of providing mezzanine financing to successful companies.
The high-risk nature of mezzanine loans means that many businesses consider them temporary loans and only take them when they are needed. The premiums tend to be higher with shorter repayment periods and interest rates are higher than many other types of loans. However, the opportunity this kind of lending provides to free up capital may make the risks worthwhile for companies that are active in expansion and investment plans. The relationship between the mezzanine lender and borrower can be a constructive one, with the lender providing guidance and support to a small business as it expands, since the lender has a stake in the company’s success.