Mezzanine financing offers a flexible and beneficial option for businesses in need of long-term capital. The typical term for a mezzanine loan is five years, with no amortization and the repayment of the principal balance at the end of the term. Mezzanine lenders take on a higher level of risk but also share in the potential rewards, making them invested in the success of the business.
Introduction
When it comes to financing options for businesses, mezzanine financing is a flexible and attractive choice for those in need of long-term capital. But what exactly is a mezzanine loan, and what is its typical term? In this article, we’ll delve into the world of mezzanine financing, exploring its structures, terms, and benefits.
Various structures
Mezzanine financing encompasses various structures that offer flexibility to both borrowers and lenders. These structures include subordinated debt with an “equity kicker” in the form of warrants to purchase common stock, subordinated debt with an equity co-investment, subordinated debt without equity, convertible debt, and preferred equity. Among these structures, the most commonly used one is a subordinated, unsecured term loan with warrants.
In a subordinated, unsecured term loan with warrants, the loan is considered subordinated and unsecured, meaning it stands behind senior debt and doesn’t require any personal guarantee or asset collateral. However, positive cash flow is a prerequisite for borrowers. Interest payments for this type of loan are typically due monthly or quarterly, with the option to accrue during an initial period, usually around twelve months. This accrual increases the principal balance. The loan term is generally five years with no amortization, meaning that the principal is repaid in full at the final maturity of the loan.
Higher interest rate
Mezzanine debt, the funding provided through mezzanine financing, is usually offered by independent funds based on an EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) multiple basis. It carries more risk than senior debt, as it is unsecured and lacks collateral. Due to its higher risk nature, mezzanine debt is typically priced at around 20% per annum. The mezzanine provider charges interest of approximately 12% per annum and also acquires a small equity warrant in the business, typically ranging from 5% to 20%.
Debt multiple
The standard mezzanine debt multiple is between 4 and 4.5 times EBITDA. Mezzanine financing is considered long-term money, and borrowers usually make interest payments without any principal payments for the first three to four years. Most mezzanine debt loans have a maturity period of five to seven years. Since mezzanine lenders own a small percentage of the business, they share a similar risk-reward profile as the business owner. This alignment of interests makes it in their own best interest to support and promote the growth of the business.
Conclusion
Overall, mezzanine financing offers a flexible and beneficial option for businesses in need of long-term capital. The typical term for a mezzanine loan is five years, with no amortization and the repayment of the principal balance at the end of the term. With various structures available, borrowers can choose the one that best suits their needs, whether it includes equity warrants or not. Mezzanine lenders take on a higher level of risk but also share in the potential rewards, making them invested in the success of the business. If you’re considering financing options for your business, mezzanine financing is certainly worth exploring as a viable solution for your capital needs.
