Mezzanine financing can get you started in business with very little overhead. Here’s what you need to know about buying a business with mezzanine financing.
While Mark Cuban once famously said that only “morons” start businesses on a loan, it turns out that a lot of great businesses were started by morons.
Look around at every great building and skyscraper, every major chain, or every tech giant and you’ll find they were started by loans. If you’re running a business that’s expanding fast, mezzanine financing can ensure that you hit the level of growth that you’re aiming for.
Here’s everything you need to know about it.
Why To Choose Mezzanine For Financing
If you’re a business owner looking to expand the kind of business that you do, you need to have working capital to get the job done. Some people go around looking for venture capital, however, venture capitalists tend to want a share of the ownership as well as direction over the company. This isn’t ideal for all bsu9einss owners.
Mezzanine financing helps borrowers who meet the requirements get the money they need to get working quickly. It’s a higher risk form or lending than other types of loans, but it also gives the lender certain advantages if a borrower defaults. As a borrower, the advantage of mezzanine debt is that the interest is tax-deductible and the debt is treated as equity.
When choosing mezzanine debt, there is the feeling that the financing is more manageable than other types of debt. Rather than having to deal with the challenges of compound interest, most borrowers can figure the interest into the total balance of their loan.
When it comes time to make an interest payment, borrowers aren’t under a lot of pressure. They could defer payments for a certain period of time if need be. They can pay part of the interest off or they could choose to put it all off.
If the company needs to save money later on interest, mezzanine debt is typically eligible for refinancing to get it all into one loan at a lower interest rate.
Lenders Love Mezzanine
While there are the aforementioned risks stated above, as most lenders don’t do a lot of due diligence, there are other benefits to a savvy lender. One of the most obvious is that lenders charge high interest rates for mezzanine loans. This is fully acceptable.
Since borrowers aren’t required to put in any collateral, this is a reasonable trade-off for many loan holders. When they don’t have to put up collateral, which in many cases is the business itself, there’s no real feeling of high risk. That high risk can cause undue pressure and actually cause some businesses to fail.
If business owners don’t see mezzanine debt as a high priority, then lenders can make a lot more money. The pre-existing debt obligations that are much older are the ones that end up at the forefront of the minds of business owners. While the debt gets slowly paid off, mezzanine lenders get to collect.
A borrower who doesn’t live up to the terms set out can convert the balance to a share of the business. If the business is growing but not as fast as planned, this is actually a fairly lucrative position for everyone.
Qualifying is Easy
While not every small business qualifies for mezzanine financing, many successful businesses do. If the business has been active in the industry for a while and has a lot of well-known products, they’re going to qualify. If they have build a reputation over the course of decades, they’ll be approved quickly.
To be considered for one of these loans, you need to offer up a great deal of financial information. Lenders are going to want to know what the plan is for growth. If they’re going to acquire other companies, offer an IPO, or start to expand, that will influence the application.
An aggressive growth plan is going to look exciting to any lender. If it shows in very clear terms how the mezzanine loan is going to help to finance and facilitate this growth, that’s all the better. If the money can be paid back easily by this growth, then the lender is going to be excited as they’ll benefit greatly.
If you default on payments, the lender would then end up with some stake in your company. If you’ve painted a positive picture, then the lender sees this as a win-win situation.
Problems with Mezzanine Debt
One of the major issues for a borrower is the potential of losing control over the business. If this is what has kept you from pursuing venture capital, you could be facing the problem under another name.
If you need to borrow for a long time, this high-interest situation is going to be a drain on your growth. Even with an aggressive growth plan, this high interest rate could quickly become an albatross around your company’s neck.
If you have a solid growth plan and the confidence that you could grow quickly, then you might need to pursue a solid senior loan instead. Mezzanine financing is great for raising money fast, in the short term, but for a sustained borrowing situation, it could hamper your financial plan.
If it’s going to take you a while to get where you want to go, then mezzanine debt might be the right plan for you.
Mezzanine Financing Offers Opportunities
No matter what industry you’re in, getting a quick infusion of cash ensures that you reach your goals. It takes money to make money and when you need new materials or help marketing your ideas, mezzanine financing can save the day.
If you’re thinking about getting a line of credit instead of a term loan, check out our guide to help you decide.