Mezzanine finance: Maven explains this lesser-known funding option

Mezzanine finance isn’t a phrase you usually hear every day, it’s a complex form of funding and whilst the mechanics of this type of finance package can often vary, in the right circumstances, it can prove a very useful means of helping businesses to achieve their growth goals. 

Julie Glenny, Investment Director based in Maven’s Glasgow office, helps to explain a lesser-known and often misunderstood funding option, mezzanine finance, in everyday terms.

1. What is Mezzanine Finance?

Mezzanine finance is effectively a loan to a business to be repaid within a defined period, usually up to 5 years. The main difference with a standard bank facility is that whilst the loan is secured, it ranks behind any senior (bank) debt and therefore doesn’t typically enjoy the benefit of tangible security cover.

2. What are the benefits?

Mezzanine finance is a very flexible debt instrument and can be structured to align repayments with business cashflows. Where a company is breaking into new markets for example or launching a new product, then repayments can be deferred for a period of 1-2 years until income generation improves. Other options include lower repayments in the early years of the loan followed by a bullet repayment at the end of the term to be repaid either from cashflow or if appropriate, a refinancing.

3. How much does it cost?

This is a common question and the answer is, it varies. Pricing will be driven on a case by case basis by the underlying risk profile of the loan and usually comprises a yield, payable quarterly, and a redemption premium.  Yield on average is priced between 10-15% p.a. The redemption premium is payable at the same time as any capital repayments and is set as a percentage of the repayment amount. For example, if the business was to repay £25,000 at the end of a quarter and the redemption premium was 20%, then the total payable at that date would be £30,000. Redemption premiums can range quite widely, anywhere between 10% to 50%, and can be set at an agreed flat rate across the term of the loan or scaled, either up or down.

4. Are there any other features?

Bank facilities remain the cheapest form of funding for businesses however where this is unavailable, perhaps where the business is embarking on a programme of growth which will reduce net assets, then mezzanine finance may be a viable alternative. It also provides growth capital without shareholder dilution, as would be the case if the business sought to raise equity, a feature which is attractive to many business owners. That said, because mezzanine is a clear enabler of growth and value enhancing then a small equity warrant is usually taken although this would trigger only in the event of an exit of the business (i.e. sale, change of control or listing).

5. What information is required by investors?

Prospective investors will expect to see a comprehensive business plan accompanied by 3 years financial projections. Post completion of investment, the investor will take Board Observer rights and expect to be provided with a monthly Board pack comprising management accounts and commercial updates from management.