Commercial real estate investors and businesses may rely on a variety of lending structures to invest and develop properties and their operations. One such structure is mezzanine financing, which sometimes fills a gap between traditional financing and equity. The experienced and dedicated commercial real estate lawyers at Sunridge Legal can help explain mezzanine financing and help you determine if it is right for you. You can schedule a confidential consultation by email us at [email protected].
What Is Mezzanine Financing?
Mezzanine financing is a hybrid between debt and equity financing. It bridges the gap between less risky senior debt and higher risk equity while embracing both features of debt and equity. Lenders may receive an equity interest in the property. Preferred stock is often used to convey an equity interest in the company. Lenders that extend mezzanine financing to debtors usually reserve this financing to companies that have a successful track record, such as an existing profitable business that is seeking to expand its operations.
What Is a Mezzanine Fund?
A mezzanine fund is a pool of capital. It invests in mezzanine finance for various purposes, including:
- Acquisitions
- Growth
- Managed buyouts
- Recapitalization
Why Is Mezzanine Financing Necessary?
Mezzanine financing may be necessary when companies need more capital than their senior lenders are willing to extend. For example, they might need money for a new project or acquisition, but their usual lender may be unwilling to lend this much money. Mezzanine financing bridges the gap between what the lender is willing to provide and the acquisition.
Terms of Mezzanine Financing
Mezzanine financing is often highly negotiated and may include specific terms, such as:
- Type of instrument – Mezzanine debt may involve unsecured debt, a second lien debt, or preferred stock.
- Equity participation – Mezzanine lenders may negotiate for equity participation as part of their debt arrangement. They may include options to purchase a certain amount of equity.
- Maturity – Maturity may be longer than hard money loans with terms of five years or longer. Another common arrangement is to have this debt mature after the primary lender.
- Interest rate – Interest rates may be higher for mezzanine financing than they are for other types of financial structures.
- Collateral – Mezzanine financing is often unsecured. In the event it is secured, the traditional lender typically has priority over the mezzanine lender.
- Covenants – Mezzanine lenders may place various covenants on borrowers that restrict or require certain actions. For example, the financing agreement may restrict the business from taking on more debt, placing liens on their property, selling their assets, or restrict payments of dividends. These terms can also require the business to provide financial reports at certain intervals and maintain insurance.
- Transferability – Mezzanine lenders may have the unrestricted right to transfer the loan at its discretion. However, the same type of transfer might not apply to equity provisions.
Benefits of Mezzanine Financing
Some of the benefits of mezzanine financing may include:
Flexible Payback Terms
According to Community and Economic Development, mezzanine financing often includes more generous or flexible payback terms than those offered by a traditional lender that make it more attractive for borrowers. For example, borrowers might be able to pay interest charges with cash, add them to a loan balance, and provide equity to lenders.
Affordability
This type of financing may be more affordable to obtain than giving away equity in the property. Stakeholders may be more willing to take on this type of financing because it does not dilute their equity.
For the lender, there are also benefits regarding affordability. With provisions for stock, the lender would not be guaranteed the payment of a dividend. However, the lender would be entitled to monthly interest payments. These loans may also provide payment of higher interest rates than traditional loans. This makes the lender greater profit while also minimizing their risk.
Tax Deductible
This type of financing also allows business owners to deduct the interest for tax purposes.
More Opportunities
If a company can secure mezzanine financing, it is better positioned to take advantages of opportunities that come along. They may be able to gain access to capital that they otherwise would not be able to receive from traditional lenders.
In some situations, businesses may first secure mezzanine financing and then try to obtain additional capital from traditional lenders. Since mezzanine financing is subordinate to other types of debt, banks may be more willing to offer debt.
Disadvantages of Mezzanine Financing
This type of financing does have some potential drawbacks for lenders or borrowers, such as:
Risk
Any time someone borrows money from another person in hope of earning more than they borrowed is always a risk. Borrowers may take on expensive debt commitments while lenders risk the borrower defaulting on the loan. If the borrower defaults, their contract may call for the transfer of equity to the lender.
Higher Interest Rates
While lenders like receiving higher interest payments, higher interest rates can add more financial commitments to a business already in need of additional funds to carry out its functions.
Restrictions
Mezzanine lenders may place special restrictions on borrowers, such as restricting any further debt loads or making other demands in order to minimize their risk.
Subordination
Mezzanine financing is subordinate to other types of financing. It is not usually secured by physical collateral or liens on other property. This puts lenders at a lower level in receiving repayment than other lenders.
How an Experienced Business Attorney Can Help
The experienced business attorneys at Sunridge Legal are familiar with various types of financing and sophisticated business transactions. Our dedicated legal team can carefully review any proposed terms of a financing agreement, negotiate terms on your behalf, and ensure your legal and financial rights remain protected throughout the process.
Contact Sunridge Legal Today To Learn More
Mezzanine financing can be a complicated form of financing, but it could potentially provide needed capital to a business. The experienced business attorneys at Sunridge Legal can explain the advantages of this type of financing, explain risks, and ensure you understand all of your legal options as you grow your business. You can arrange a confidential consultation by emailing our legal team at [email protected].
