The first thing to know about mezzanine financing is that it can function as a bridge between your financing needs, and what lenders are willing to provide. If for whatever reason – low business credit score, multiple preexisting loans, etc – you are unable to secure the full amount for a project, then a mezzanine loan may be a viable alternative.
What Does a Mezzanine Loan Consist Of?
In particular, this non-traditional type of funding is a package consisting of debt and equity for the lender – with the option to add equity interests. As expected, such a robust package is often offered only to companies with a solid record of loan repayments, because the associated costs often exceed those of traditional loan packages. Some of the more common reasons for procuring a mezzanine loan is for the acquisition of properties beneficial to your business (expected), or simply to improve the reach of your current business.
Considerations Before Requesting a Mezzanine Loan
As with all investment vehicles and loans, there are some plusses and minuses to this one. From the perspective of the lender, there are higher interest rates associated with the mezzanine variant to reflect the higher inherent risk of offering a loan that has a lower priority in the event of borrower default. You may not be able to recoup any physical collateral in case of the latter, so the higher interest rates allow you larger income payments upfront. Another bonus is the frequent attachment of equity to the loan, which elevates your compensation as the borrowing business becomes more and more successful.
As for the drawbacks of a mezzanine loan, the primary one isn’t any different than with any loan: you (the lender) risk the loss of money if the borrower defaults. The high interest rates are a hedge against this, but the low priority of this type of loan also means you may end up being unable to secure property as collateral after the more senior lenders are satiated.