A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.
Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender this type of financing is aggressively priced with the lender seeking a return in the 20-50%p.a. range.
When to use it?
Mezzanine finance is raised by property developers to finance large scale property developments such as building residential units. Mezzanine finance is used in conjunction with bank loans and the property developer’s own equity to fund the development. In the event that the developer goes bankrupt, mezzanine finance investors stand second in line to the banks to receive their dues, hence explaining the higher rates of interest offered.
The risk with mezzanine finance hinges on the credibility of the property developer, property market conditions and the particulars of the contract.