Mezzanine Financing is a popular method of corporate financing, a compromise between a bank loan and emission of shares. In such a way, successful businesses, which require additional capital for fast development and critical sizes, necessary to achieve the next step of financing of the company while its shareholders maintain the control, are financed. Mezzanine is also used for financing of management or leveraged buy-outs.
Companies choose Mezzanine Financing for a couple of reasons:
- Maintenance of shareholder structure: Mezzanine capital is used when shareholders of a company want to raise capital while trying to maintain the control of business. Issue of equity capital reduces the share of current shareholders in the company as well as their control in it; this is the compromise proposed by private equity funds, however we understand that such compromise does not appeal to all firms.
- Exceeded borrowing limits at banks: Mezzanine capital is an additional funding for companies to which bank financing is not accessible due to their high level of debt, insufficient financial collateral and low equity capital. It is a common problem of fast-growing enterprises when income is insufficient to finance the envisaged developmen
- Cheaper funding: Mezzanine type capital is a cheaper growth capital than the funding by a new issue of shares when the initial public offering is organised and proposed at stock.
Examples of Mezzanine Funding
Software company generating 12 million EUR a year required additional capital to develop a new project. As the bank disagreed to lend a necessary amount, the Head of the company contacted business angels, but the financing from investors would have been received only by giving them a big part of the company’s shares. In order to find an alternative, the company contacted a financial intermediary who found a person that agreed to lend 1.5 million EUR with 10 % annual interest rate and a guarantee to acquire 15 % of the company’s shares at the maturity of the term.
Cardboard production company tried to renew one of its production lines. Due to the loss incurred within the last year, the bank did not agree to finance the whole amount of the project; however, it agreed to provide a partial loan in case the company increases its equity capital. Venture capital funds were not interested in average growth company that is not receptive to technologies, but even if they were interested, they would have required a big portion of the company’s shares; owners of the company were not ready for such a compromise. Finally, the company contacted a finance intermediary who found 900 000 Euro funding with 14 % interest rate and the guarantee to acquire 9 % of the company’s shares at the maturity of the term. The agreed interest rate was quite high; however, this is the price that the company agreed to pay to maintain its management rights. The company also had benefit because the bank agreed to fund the remaining part of the project value and the project was implemented.