Mezzanine Finance

Specifics

Mezzanine finance is a form of hybrid credit, consisting of both borrowed capital and equity finance. It allows businesses to fund their growth, even if they lack sufficient guarantees to obtain bank loans.

1. Mezzanine finance is generally aimed at businesses:
   • Involved in a takeover process (family) or leveraged buyout (LBO) or which want to develop promising projects without bearing the full cost of financing the project themselves;
   • Which are no longer able to draw on bank loans (‘senior debt’) due to a lack of sufficient guarantees;
   • Which want to avoid increasing their equity capital or extending their capital to new shareholders for fear of losing or diluting control over their development strategy.
2. The key features of mezzanine finance are:
   • Diversity: mezzanine finance is always made to measure, varying from the simplest form (subordinated loan which, in the event of the issuer’s bankruptcy, will be paid back after the reimbursement of all the other creditors) through to complex structures (e.g. convertible bonds which, at maturity, offer the creditor the right either to demand the redemption of its original loan or to convert all or part of its loan into shares and/or warrants);
   • Subordination: mezzanine finance is always subordinated to traditional bank loans;
   • Cost: mezzanine finance is subordinated to senior debt, making it more expensive than traditional funding.

Advantages

• Achieving your strategy: mezzanine finance is generally redeemed at maturity, which means it contributes to the growth of the business, while preserving its cash reserves.
• Non-dilutive finance: mezzanine funding mostly offers only limited access to equity and so shields the issuing company from an undesirable dilution of its capital.
• Complementary to traditional finance: mezzanine funding is treated as quasi-capital, allowing businesses to strengthen their equity while complementing traditional forms of finance, which require more substantial guarantees.

Good to know

• It is essential to involve your relationship manager and a Corporate Finance expert as early as possible in the analysis of your strategic options.
• Mezzanine finance complements traditional bank finance rather than replacing it. Only when that source of finance has been exhausted does the business turn to mezzanine funding. It can, by contrast, offer an alternative (or a complement) to an increase in equity capital.
• The risk associated with mezzanine finance is higher than that of traditional bank funding because of the inferior level of guarantee (which justifies a higher interest rate). If the business should fail, the lender will be reimbursed after the holders of the senior debt, but before investors in the equity capital.
• Remuneration for mezzanine finance frequently comprises an interest rate (Euribor plus a margin) calculated according to the expected return on equity. This remuneration is higher, given the higher degree of risk compared to senior debt (to which it is subordinate).
• Mezzanine finance is generally provided for a fixed period, with the amount borrowed redeemed in full at maturity.