Mezzanine financing

Imagine your company needs funding to pay for a new growth initiative. You need more funding than you can reasonably secure with a standard business loan, or funding such as a merchant cash advance, bridging loan, or commercial mortgage, and you don’t feel confident in gaining a fair valuation at this stage of your journey, so equity finance is off the table. You’re comfortable with the possibility that a lender could buy part of your business (and therefore get a say in how things are run and a percentage of future profits) for less than it’s worth at the time, and you’re happy to pay additional interest. 

In this instance, you might decide mezzanine finance is suitable for you. The next step would be to find a lender willing to extend funding in this hybrid fashion. A broker may be able to help you there, or you could try reaching out directly to lenders one by one. If you choose the second option, you might want to try specialised lenders whose operation model doubles up as an investor or have an investment fund arm. 

At this stage, you and the lender may negotiate terms. The lender may ask for an objectively higher interest rate, they may offer a certain repayment schedule, and they may outline how much equity they’d like to be able to purchase if they choose to, and at what rate. 

During the negotiation stage, consider carefully if you would like to go ahead with this – are these the terms you’re comfortable with? Are you able to meet the repayment schedule? Are you definitely okay with the lender becoming a dual owner in the business with you? 

Once you’ve agreed terms, the lender may take a more careful look into your business plan, cash flow, outgoings and revenue, the team’s experience, and other markers that will help them assess the current value of your company and what potential for growth they see in the business. 

Finally, you will both sign an agreement that outlines the terms, including the conditions of the equity kicker. You’ll then make regular interest payments, usually on a monthly basis. 

Towards the end of the term, you may need to make a large payment to clear the debt. If your business grows, the lender may choose to purchase the agreed portion of the company. If your business struggles with the loan, they may convert the remaining funds owed into equity in the business, possibly even taking more of an active role in the business in an attempt to ensure they get more out of their investment. 

We’re one of the leading business finance brokers in the UK, having helped facilitate over £850 million in funding for more than 18,000 customers. Our experience means we’re able to take a third-party, unique look at your circumstances and help you understand exactly which funding might be best suited for you, and which of the 120+ lenders we work with might be most likely to fit your needs. Beyond mezzanine finance, we also help facilitate revolving credit facilities, invoice discounting, unsecured business loans, and more. 

Our customers say it best, so if you’re interested in learning more, we recommend checking out our customer stories. Or, if you want to start the search for finance now, get a quote here to find out if you’re eligible for up to £20 million in funding. One of our expert advisors will be in touch. 

Example: Let’s say you want to sell your company. You’ve found a private equity company that wants to buy your business, but they intend to do this using borrowed money. This is known as a leveraged buyout. They’ve found a bank willing to front most of the cost of your business, but they need a little extra to complete the sale. 

They may turn to mezzanine finance as a way to cover that last bit. They would likely pay additional interest when compared to the large loan from the bank, but they consider this fair given if the business does go bankrupt, the mezzanine lender only gets their money back after the bank gets theirs. 

Example: Now let’s say you’re the one who wants to buy a company. You’ve found out a smaller competitor is on the market, and you think buying their business would help you expand into an exciting new vertical. 

You have over half the money required to make the acquisition, but you need the rest and it’s a pretty extensive amount to borrow from a traditional bank. You’re also not sure you want to bring in another investor, as you want ownership over how this acquisition will function. In this case, you might use a mezzanine lender to borrow the remaining funds, which you will pay back once you’ve seen the profits from the acquired business, and in exchange, you will let the lender buy a small portion of the business at some point in the future, if they want to. 

As with any finance solution, there are risks and drawbacks to mezzanine finance that you should be aware of before entering into an agreement. For starters, you may experience more growth than expected, at which point, the lender could buy their agreed portion at a heavily subsidised rate. 

The high interest rates can eat into profitability, which can impact your ability to effectively run and grow your business. Some mezzanine finance providers put restrictions in place on how much further funding you can secure from additional sources. We highly recommend going in with a solid business plan and a well thought out exit strategy. 

Mezzanine finance can be used for a range of business purposes, including

• Purchasing a business

• Growing into a new vertical, market, or geography

• Facilitating a management buyout

• Expanding a company’s operational activities

• Developing property 

• Funding the construction of new builds

Mezzanine finance generally comes with higher interest rates than a traditional loan, more finance, and the option for the lender to purchase or take ownership of a portion of the business in future. There are usually more flexible repayment terms, for instance, you may only need to pay interest for the length of the term, and then a large balloon payment at the end. 

All forms of finance carry risk. How risky a given form of finance is depends a lot on your circumstances. While only you and a financial advisor can determine the exact level of risk for your business, there are some key considerations to bear in mind when thinking about risk as it applies to this version of funding. 

For starters, mezzanine loans come with higher interest rates. Higher interest rates inherently carry more risk since the more money you have to pay out, the less you have for operational activities and business growth. The final balloon payment also carries risk – it’s a large payment that you may not have the funds for at that time. It’s a big responsibility to take on. 

There’s also the possibility that the lender will exercise their rights to take over part of the business at a time when you may not want them to.

Typically, the agreement may span over a period of seven years, sometimes less, sometimes more. You will likely make regular monthly interest payments. At the end of the term, you may have to pay a large balloon payment that clears the debt. 

This is similar to some types of car finance – where you pay the interest for a few years and then decide at the end of the loan term if you’d like to keep the car, at which point, you make a large payment that covers the remaining value of the loan. 

If you don’t manage to pay the balloon payment or the interest payments, the lender may convert the loan into equity. They may also decide to buy a portion of the company if it does well.

Mezzanine finance enables a lender to be able to purchase a portion of your company at some point in the future (by which time it may have grown in size) for a cost that you both agree to before the funding is extended. This means your business ownership may be diluted at some point, but not necessarily.

Securing mezzanine finance can be a longer process than might be involved with some forms of debt finance, such as invoice finance or short-term business loans. This is because there is some degree of valuation and due diligence involved, even if it’s not done to the same extent involved in securing equity finance.

Mezzanine finance combines the features of both debt finance, which involves regular repayments with the addition of interest, with equity finance, which involves selling a portion of the company in exchange for funds. But with mezzanine finance, unlike equity finance, the ownership feature isn’t a given. 

Property developers can use mezzanine development finance to bridge a gap between their deposit and the property development finance they receive from a lender to fund their project. Mezzanine finance provides the developer with a way to maximise their return on investment with minimal upfront costs because it means they can pay a smaller deposit.

As well as reducing the deposit amount required, mezzanine finance can be used to fund a gap in a deposit or to enable the developer to reserve funds for future deals. The lender can usually cover up to 90% of project costs, leaving the developer to contribute 10%.

In terms of lending criteria for property mezzanine finance, developers will usually have to prove their experience, full and detailed planning consent must be granted and personal guarantees will be required. Valuation Reports & QS/ MS reports instructed by the senior lender may also be used by and addressed to the mezzanine finance lender.

Mezzanine finance can also be used for management buyouts (MBOs) or leveraged buyouts (LBOs). These arrangements work in a similar way to standard mezzanine finance, but instead of a single asset, property or project it’s an entire business being financed.

LBOs and MBOs depend on specific circumstances of the business being bought so it’s tricky to generalise, but overall they’re a way to use the value of the business being bought as the security.

As an alternative to mezzanine finance, you might be able to get the full amount you need from a single lender. When you use Funding Options by Tide to find business finance, we’ll match you with the best deals for your situation and short-term goals. Our Finance Experts are also on hand to guide you through the application process. Mezzanine finance is clearly a complex product, but it has its uses. If you’re looking for mezzanine finance, or just researching the various ways to fund a project, we can help you find the funding that fits best from dozens of lenders across the whole market.