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There are many different financing options available to the general public and business owners right now, and one of these options is called mezzanine financing. This option is available to business owners and can be the solution to many problems that they face.
In this article, we are going to be looking at what this is, how it works, and some of the advantages and disadvantages of using this type of financing. Keep reading to find out more on this topic!
What Is Mezzanine Finance?
This is a mixture of equity and debt financing, which allows the lender to convert to an equity interest in a company in case of default after venture capital companies, and any other senior lenders have already been paid.
This kind of debt has equity instruments attached, which are also known as warrants, and what these do is increase the value of the lower level debts as well as give more flexibility when it comes to dealing with a bondholder.
You will largely see this type of financing used if someone is trying to buy out a company, as it prioritizes the needs and the interests of the new owners, rather than the current ones should there be any bankruptcy claims filed.
How Does It Work?
Mezzanine finance is one of the highest risk forms of debt that there is. It is subordinate to pure equity but does rank above pure debt. Even though this is high risk, the returns are often far better than other types of debt, and lenders could be looking at between 12-20% per year.
It is more common to see this type of financing sought after if an acquisition is taking place, or if a business is trying to grow in a certain way.
While you may not see that there is a bright side to this just yet, the people who provide this type of financing option are usually long-term investors of the company which makes it far easier to obtain other types of financing, should they be necessary.
If there are long-term investors involved, this shines a more positive light to other lenders and means that they are more likely to extend credit and produce favorable terms to the company.
Advantages and Disadvantages
The investor’s rate of return is likely to be significantly increased, which is certainly a benefit for them. As well as this, the mezzanine finance providers receive interest payments that have been contractually obligated, and these can be paid either monthly, quarterly, or annually.
It is also the case that this kind of debt is tax-deductible, and the structure that it operates under is more manageable for most people. This is due to some of the interest being deferred should the borrower not be able to make a payment, which is not usually available with most other types of financing.
However, the owners of the business do end up giving up control of their company. The interest is also only ever-increasing the longer that this financing option is in place, so it could be the case that the owner ends up paying massive amounts in interest.
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