Mezzanine funding is an underdog in the funding landscape, not often spoken about in conversations, but a lifeline for some businesses. In this article, we’ll discuss how this type of capital works, who it’s designed for, and most importantly, when it actually makes sense for a business. Mezzanine finance can help a business scale without giving up large chunks of ownership.
Think of mezzanine funding as a tool that sits in the middle zone of a company’s capital structure, between senior bank loans and full equity investment. That “in-between” positioning is where the name comes from.
Mezzanine – the Middle Man
A mezzanine fund serves as a middleman between senior debt and a company’s equity. Understanding senior debt is crucial here, as you might not need to jump to mezzanine if you haven’t maxed out what your business can get from traditional lenders. Mezzanine financing essentially steps in when banks are hesitant to offer more debt. Thus, when companies are in a position where they are not yet ready to clear their senior debt, they turn to mezzanine financing.
Why this Type of Funding Exists
A gap between senior debt and equity financing happens when a company can’t easily get loans to cover everything it needs. So, to fill the financial gap without immediately giving up more ownership, companies turn to mezzanine funding.
This gap exists because of a few reasons:
- Banks are extremely cautious: Banks don’t often place much value on a business’s inventory, money owed by customers, and fixed assets; hence, they are discounted.
- Intangible assets: Companies tend to record intangible assets on balance sheets. Examples include patents of goodwill and software. Banks find it harder to use these as security.
- Bank Rules: Banks are limited in terms of the risk they can take when borrowing funds. Terms are more strict when it comes to businesses, so they set limits on how much senior debt a company can borrow.
Advantages of Mezzanine Funding
When funds have been planned strategically, the chances of the company reaping the benefits are high. But it’s always important to know why you’re seeking funding and what you will do with those funds. The benefits of mezzanine funding are as follows:
Keeps You in Control
One of the biggest selling points for founders is that mezzanine finance doesn’t swallow your ownership. You still raise a meaningful amount of capital, but you don’t walk away feeling like you handed over the keys to your business.
A Structure You Can Bend to Fit Your Situation
Mezzanine financing offers your business breathing space and flexibility. Lenders can build in things like interest-only periods or even allow interest to “roll up” instead of being paid right away. If you’ve ever had to manage lumpy cash flow, you know how valuable this kind of flexibility is.
Tax Relief Softens the Cost
Another practical advantage is the tax break. Because interest is usually tax-deductible, the actual cost of this funding ends up being lower than it looks on paper. For cash-conscious SMEs, this can make a real difference.
Fuel for Bigger Moves
Mezzanine capital is usually tied to major financial moments in a business, like buying another company, taking over a partner’s share, or scaling faster than a bank loan would allow. Once the bank caps out your senior debt, mezzanine often steps in to bridge the gap.
Designed for Long-Term Plays
With mezzanine, you typically don’t have to pay right away, which gives you time to put the money to work and build momentum. It waits for the business to grow instead of demanding instant returns.
No Heavy Collateral Needed
This is one of the biggest benefits of mezzanine funding. Unlike traditional loans, which require you to put your machinery, property, or personal assets on the line. It usually leans more on the business’s performance and future potential.
Disadvantages of Mezzanine Funding
Like most forms of funding, there are both advantages and disadvantages. These disadvantages are:
Higher Interest Rates
This flexibility of the funding comes at a cost. The lender expects higher returns because they take a higher risk.
Higher Risk for Lenders
While a senior lender may walk away with assets if the business fails, mezzanine lenders only get paid after the bank does. They rely on the business to perform. This is why they look deeper into strategy, leadership behaviour, and market positioning than banks usually do.
