- Mezzanine loans blend equity and debt and sits somewhere between senior debt and equity
- They are associated with high interest rates but flexible repayment plans
- Mezzanine financing can be advantageous for companies looking to accelerate at a faster rate than traditional lenders can offer
How do Mezzanine Loans Work?
Mezzanine financing acts as a capital resource and falls between senior debt and equity. Through this, it maximises the total leverage with negligible equity dilution. The terms and conditions of a mezzanine loan are dependent on the agreement between a business and the lender. For lenders, mezzanine loans balance out the high risk with potential for extremely high rate of return, often receiving annual rates of between 12% and 20%, and even as high as 30%.
When working as a mezzanine lender, it is recommendable to work with an already established company with a successful history of business transactions. If investing in a less established business or start-up, the stakes are higher, and there is more risk. As such, the interest rate may be higher and the repayment plan more flexible. Whatever the agreed terms, mezzanine loans blend debt and company equity to benefit both parties. Typically, mezzanine loans have a fixed interest rate with no amortisation.
Characteristics of a Mezzanine Loan
- They are subordinate loan and are low priority compared to senior debt but take priority over common stock
- They have higher yield potential than ordinary debt
- There is no amortisation
- Repayment is usually flexible: Mezzanine loans can be structured as part fixed and part variable interest
- They are commonly unsecured debts (not backed by collateral)
Repayment Plans and Interest Rates
Mezzanine loans are associated with higher costs than traditional borrowing. Lenders can ask for traditional repayment (often in the double-digits) or they could request equity exposure in order to supplement the interest.
Repayment plans tend to be more flexible with these types of loans. For businesses, cash flow is not always available. Mezzanine loans recognise this and, as such, offer the option for companies to capitalise interest charge by means of ‘payment in kind’ (PIK). This means that the company is able to offer repayment in a form other than cash. This can be a good or service but, in this case, typically refers to bonds, stock or equity.
When Do you Have To Pay Back an Equity Loan?
Mezzanine loans are an example of a subordinated loan. This means that they are low priority for repayment. In the event of a business failing, it is possible that they are not able to cover all of their debts. In the hierarchy of repayment, mezzanine loan repayment is low priority and can only be paid after all other, high priority payments have been covered. Top priority payments are usually the banks and senior shareholders. Mezzanine loans are further down the list than these payments but they fall above common equity.
