BusinessCalculationFinancing

What is mezzanine financing

What is mezzanine financing

This is a situation in which a company uses the two methods of financing which are the debt financing and the equity financing. The hybrid of the two in which the investors can convert their bonds or shares to any of the corresponding financing securities is known as mezzanine financing. It gives the lenders or investors the right to converts his ownership to an equity interest should there be any case of default in the company after other equity investors and high ranked lenders in the company are paid. In mezzanine financing, the borrower tends to give the lender with little or no collateral while the lender provides with little due diligence.

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Mezzanine financing is the most expensive source of financing for a company unlike the equity financing or the debt financing. The high amount of capital used in the financing of mezzanine financing makes it to be unsecured and subordinated and increase the risk of the investment. The mezzanine financing always attaches convertible bonds in the warrants which means the bond can be converted into stocks but all the equity investors get paid before the bond investor in case of any defaults.

What is mezzanine financing

This gives a lender an opportunity to take part in the running of the company and as an owner of shares in the company, his suggestions can be reviewed as though he can give suggestion in the financing of the company. Mezzanine lenders often charge a payable upfront and arrangement bill at the end of the transactions that is when the transacting is to be closed.

Mezzanine financing breaks down

Before a company can go into mezzanine financing, the company must provide a good record of their industry with reputations that are established and products. The company must be able to provide the record or the company profitability and how the plan for the business expansion gets viable. The interest of the mezzanine finance is usually between the ranges of 12% to 20%. This makes the risk to be very high because if the high return debt.

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In mezzanine financing, the part of the capital which the equity investors should provide are replaced by the debt finance. For example, a company that has an investment of $120m but has $20m in its account and the equity financing of $20m. Typically, the equity investors should have provided the $100m that remains but the debt financing investors provided the $80m while the equity investors provided $20m. This makes the risk to be very high as the financing of the investment with debt is higher than the equity financing. The companies that use mezzanine financing leverage their return while they were providing less of the investment capital.

In mezzanine financing, the lenders may result in having the ownership in the company or becoming the equity investor or maybe provided with warrants to be able to purchase shares in the company making him an equity investor from the lender he had been before.

With this, the company has a greater rate of return as it will not be paying back the money borrowed from the lender and also providing it with an interest which will definitely reduce the investment return. So consequently, the investors rate of return (ROR) increases. The average returns from the mezzanine financing investments earns up to 19% annually. This makes the ROR to always be greater than the interest rates. Borrowers would prefer to get into mezzanine debt because the interest can be deducted from the tax on the company.

For example, if the interest on the debt is meant to be $40, the company pays back $35 because of the tax rate of $5 on it. One of the advantages of mezzanine financing is that it is more manageable than any other debt structures because the borrowers can convert the interest into balancing of the loan.

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For example, we can see the issue of mezzanine finance in SALVARDORR BUSINESSS ENTERPRISE. The owner of the company had $25m in his own account but needs $80m for the financing of an investment. The owner had put up an equity of $15m and a borrow money of $40m. The owner has a returned of $40m but had to pay $5m on the borrowed money but because of the tax deductible of $2m. He had to pay the lender $3m.

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Harish Yadav

Finance and market analyst and chief writer on howtofinance. Passionate to read books and articles on marketing and accounting. Also edits other articles and publish them here.

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