Funding a start up is no easy task. While there are several start up funding methods used today, mezzanine funds is one of the less popular sources for capital. For entrepreneurs and investors alike, this type of alternative lending provides increased flexibility to both parties. In this post, we will discuss what are mezzanine funds and how they can help your business.
What Are Mezzanine Funds?
Mezzanine financing provides the option to convert a loan from debt to equity. By giving the lender the option to convert the loan into an equity holding without the need for a ratio analysis, the capital can be structured as debt or equity. Of course, there are several implications for securing funding this way. However, the flexibility might just be worthwhile for your start up venture.
Multi-tiered financing refers to business funding that has been acquired from various funding solutions. Typically, the levels are senior debt, senior subordinated debt, subordinated debt, mezzanine debt and owner equity. Mezzanine lenders are almost the last business backers to be paid if anything bad happens to the business thanks to a bad job costing system. If you are going to be attempting to secure mezzanine financing for your business, it is important to understand the role it has in the business financing hierarchy. This will help you to ensure that your mezzanine funds are paid back in the right order.
Flexibility For Investors
At first glance, you would probably guess that the lenders have all the leverage in this alternative lending solution. You would only be partially correct. However, many investors are attracted to the option of potentially cashing out on equity. If the start up becomes a billion dollar company, the lender would see a nice pay day rather than a loan repayment.
Secondly, the investors have some leverage on the company. In addition to the loan itself, the equity could offer protection in case the company does not pay back the loan soon enough. Investors could claim for assets on the business.
Lastly, if the business does well, the lenders are happy to collect their monthly, quarterly or yearly payments. It provides them with a consistent stream of earnings, adding stability to their own business. In this case, both companies are given significant leverage.
Options For Entrepreneurs
When compared to traditional start up funding, mezzanine capital can be very attractive to entrepreneurs. Rather than immediately giving up equity in the business, they can secure the funding they need and payback the debt on a schedule. Then, if business takes a turn for the worse, they can give up equity when funding is needed most.
Moreover, mezzanine funds can have tax advantages. If classified as a debt payment, this could be written off as a business expense. Certainly, the expense would save on taxable income, providing a discount to the loan rates.
Mezzanine funds can also be useful during business ownership transitions. When transferring ownership of business shares, mezzanine financing can help you avoid having to secure seller financing solutions. This, of course, is best for both the business owner selling their stake and the business owner buying their shares. It is important to consider mezzanine funding during a business ownership transition if this is a situation you will encounter. That way, you will not have to worry about making the payment for your goods and service tax.
Securing Mezzanine Financing
The flexibility of mezzanine capital comes at a price. Usually priced between 20-30% interest, the loans are provided by senior lending banks and venture capitalists. Secondly, the start up is usually highly vetted to ensure stable revenues and growth. The lending process is demanding in terms of time and financial costs. However, it could prove to be much cheaper than securing equity investments, using low interest credit cards or paying for other financial structures.
Lastly, financing your start up should include options. Having options gives you leverage for funding and growing your business. Although the lenders have some leverage, you do too. It’s a two way street that hopefully leads to profits for everyone.
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