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 launching 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 complete 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 it can be used as a substitute for bank debt and equity financing.
This type of capital is considered “junior” capital in terms of its priority of payment compared to the senior secured debt, but it is higher than the capital stock or the capital stock of the company. In a capital structure, it ranks below senior bank debt, but above equity.
- Intermediate financing lenders are cash flow, not collateral-focused: These lenders typically lend based on a business’s cash flow, not collateral (assets), so they often lend money when banks don’t if a business lacks tangible collateral, provided the business has enough cash flow 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 that owners give up less additional capital, if any, to fund their growth .
- Flexible and non-amortizable capital: There are no immediate principal payments; Typically this is just principal with a balloon payment at maturity, allowing the borrower to take the cash that would have been used for principal payments and reinvest it in the business.
- Long-term capital: It typically has a maturity of five years or more, making it a long-term financing option that will not have to be repaid in the short term; it is generally not used as a bridging loan.
- Current owners maintain control: Does not require a change in ownership or control – Existing owners and shareholders maintain control, a key difference between obtaining mezzanine financing and obtaining capital from a private equity firm.
- More expensive than bank debt: Since junior equity is often unsecured and subordinate to senior loans provided by banks, and is inherently a riskier loan, it is more expensive than bank debt.
- Warrants can be included: To take on greater risk than most secured lenders, intermediate lenders will often seek to participate in the success of those to whom they lend and may include collateral that allows them to increase their return 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 enables a family member to provide liquidity to the current business owner.
Shareholder liquidity: financing a dividend payment to shareholders.
Financing of new leveraged acquisitions and management acquisitions.
Great capital option for companies with light assets or service companies
Since the tendency of mezzanine lenders is to lend against a company’s cash flow, not as collateral, mezzanine financing is a great solution for financing service businesses, such as logistics companies, staffing companies, and software companies, although it can also be a great solution for manufacturers. or distributors, who usually have many assets.
What These Lenders Are Looking For
While there is no single business financing option suitable for every situation, here are some attributes that cash flow lenders look for when evaluating new businesses:
Limited concentration of clients
Steady or growing cash flow profile
High free cash flow margins – strong gross margins, low capex requirements
Strong management team
Low business cyclicality that could result in volatile cash flows from year to year.
Lots of cash flow to support interest and principal payments
An enterprise value of the company well above the debt level.
Non-bank growth capital option
As bank lenders face increasing regulation over tangible collateral coverage requirements and leveraged loan limits, the use of alternative financing is likely to increase, particularly in the middle market, filling the capital gap for business owners. looking for funds to grow.