If you are raising growth capital to expand your business, you may want to consider using mezzanine financing as part of your financing solution.
Mezzanine financing is a form of debt that can be a great tool for financing specific initiatives such as plant expansions or the launch of new product lines, as well as other important strategic initiatives such as buying a business partner, making an acquisition, financing the payment of dividends from a shareholder or completing a financial restructuring to reduce debt payments.
It is commonly used in combination with bank-provided term loans, revolving lines of credit, and equity financing, or can be used as a substitute for bank debt and equity financing.
This type of equity is considered “junior” equity in terms of its payment priority to senior secured debt, but is senior to the company’s equity or common stock. In a capital structure, it is below the main bank debt, but above the equity.
Advantage:
- Mezzanine finance lenders are focused on cash flow, not collateral: These lenders generally lend based on a business’s cash flow, not collateral (assets), so they will often lend money when banks won’t if a business lacks tangible collateral, as long as the business has sufficient cash flow. cash available to pay interest and principal payments.
- It is a cheaper financing option than raising capital: Pricing is less expensive than raising capital from equity investors such as family offices, venture capital firms, or private equity firms, meaning owners forgo less, if any, additional capital to finance their increase.
- Flexible Capital, Non Amortizable: No immediate principal payments: Usually just interest principal with a balloon payment due when due, allowing the borrower to take cash that would have been earmarked for making principal payments and reinvest it back into the loan. business.
- Long Term Capital: It typically has a maturity of five years or more, making it a long-term financing option that won’t have to be repaid anytime soon; it is not generally used as a bridging loan.
- Current owners remain in control: Does not require a change in ownership or control: Existing owners and shareholders remain in control, a key difference between obtaining mezzanine financing and raising capital from a private equity firm.
Cons
- More expensive than bank debt: Since junior equity is often unsecured and subordinated to senior loans provided by banks, and is inherently a riskier loan, it is more expensive than bank debt.
- Warranties may include: Taking on more risk than most secured lenders, mezzanine lenders will often seek to participate in the success of those they lend money to and may include collateral that allows them to increase their yield if a borrower performs very well.
when to use it
Common situations include:
- Fund rapid organic growth or new growth initiatives
- Financing of new acquisitions
- Purchase from a business partner or shareholder
- Generational transfers: source of capital that allows a family member to provide liquidity to the current employer
- Shareholder liquidity: financing the payment of a dividend to shareholders
- Financing of new leveraged purchases and management purchases.
Great capital option for service or asset light businesses
Since mezzanine lenders tend to lend against a company’s cash flow, not collateral, mezzanine financing is an excellent solution for financing service businesses, such as logistics companies, staffing firms, and software companies, although it can also be a great solution for manufacturers. or distributors, who often have many assets.
What these lenders are looking for
While no business financing option is right for every situation, here are some attributes cash flow lenders look for when evaluating new businesses:
- Limited customer concentration
- Consistent or growing cash flow profile
- High free cash flow margins – strong gross margins, low capex requirements
- Strong management team
- Low business cyclicality which could result in volatile cash flows from year to year
- Abundant cash flow to support interest and principal payments
- An enterprise value of the company well above the level of debt
Nonbank Growth Capital Option
As bank lenders face increasing regulation on hard collateral coverage requirements and leveraged lending limits, the use of alternative financing is likely to increase, particularly in the middle market, filling the capital gap for banks. business owners looking for funds to grow.