Mezzanine Financing :

Over the years, mezzanine financing has emerged as a funding tool that businesses opt for meeting their expansion goals. The reason for it is the amount of loan available via mezzanine financing and its placement in the debt’s structure of risk level.

What Is Mezzanine Financing?

Fundamentally, mezzanine financing is a hybrid of equity and debt financing. It allows lenders to convert loan value into equity in case the borrower fails to repay the debt. Such a right can be exercised after payment is made to the senior lenders such as venture capital companies, private equity companies and others.

It is structured in a way so that  it includes a portion of fixed and variable interest. This type of financing is subordinate to senior debt and is often unsecured.

Lenders can often extend mezzanine finance as a top-up or in addition to funds. Mezzanine financing enables borrowers to avail a larger percentage of their capital requirement than most conventional loans. 

The said financing occupies the form of preferred stock or unsecured and subordinated debt. Though its structure is inclined towards debt, mezzanine finance imitates equity in an aspect of both growth and performance.  

How Does Mezzanine Financing Work?

Mezzanine financing comes in handy when a business has surpassed its asset-based loans or bank credit limit. Under this funding option, the money borrowed has to be repaid through the revenue generated.

The lender loans money to the borrowers to help them meet their financial requirements. They also earn interest as per applicable rate on the lent amount. After a predefined time limit, a portion of the loan amount gets converted into equity if the entire due amount is not paid off. 

Often under mezzanine financing, business entities also use their company’s equity as security against the loan value. 

Benefits Of Mezzanine Financing:

With the help of mezzanine funds, an individual can buy a company or expand his/her business venture without opting for an IPO. 

Other than that, some noteworthy benefits of mezzanine capital financing include the following:

  • Ease of availing loan: Mezzanine loans are easier to borrow when compared to other conventional loans. The financing option also provides borrowers with at least 3 times of what a regular lender may offer in terms of the loan value. 
  • Flexible loan structure: Borrowers avail loans from multiple sources and the amount borrowed from each lender is significantly small. 
  • Value creation: The presence of a mezzanine investor on board is often perceived positively by shareholders. It helps paint a favourable picture of the company in the market.
  • Tax exemptions: Tax deductions on the interest paid on a loan amount makes it a feasible funding option for MSME owners.
  • Control and interference: Company owners rarely lose control of their firm or its direction under this financing option. Unless a company performs poorly, mezzanine lenders rarely interfere

However, factors such as covenants and a high interest rate accompanying this funding option are considered as its shortcomings. Business owners can avoid the impact of both and seek a more flexible financing option in terms of interest rates and other lending conditions.

Businesses can also  opt for invoice discounting service from KredX to avail instant working capital to meet their financial requirements. Since KredX offers a zero-liability bill discounting service to businesses  there is no impact on their balance sheet.

Difference Between Mezzanine Financing And Bill Discounting:

The table below offers a fair idea about the fundamental differences between mezzanine and bill discounting. 

Parameters

Mezzanine Financing

Bill Discounting 

Definition

Mezzanine financing is a financing process wherein a business’s equity shares are leveraged to raise funds.

Bill discounting is the process wherein business owners raise capital against all bills of exchange.

Purpose 

It comes in handy to boost growth capital. Also, it assists in filling the gap between the senior debt and equity in a company’s capital structure.

It comes in handy to meet immediate working capital requirements. Further, it helps to boost production and sustain profitability. 

Suitability 

It suits companies that are beyond their start-up stage and are planning expansion. Also, those who cannot acquire capital through other financing options may resort to mezzanine finance. 

MSME owners who need working capital to maintain smooth business operation find bill discounting a  suitable option.

Type of loan

Intermediate financing option.

Immediate financing option.

Eligibility 

Businesses must have a clean credit history, a consistent track of generating revenue and a functional plan of expansion through acquisition or an IPO.

Usually, the eligibility criteria are relatively simple to avail loan against bills receivable. However, it depends mostly on borrowers’ creditworthiness and worth of the bills under the scanner. 

Businesses looking for quick access to working capital can avail instant invoice discounting service  from KredX within 24-72 hours*. 

Example Of Mezzanine Finance: 

Suppose Mr. Jaiswal owns a fast food joint. He plans to expand his venture, but lacks the adequate capital to execute the plan. Also, he is not keen on trying a conventional equity financing option. Meanwhile, he decides to opt for mezzanine financing.

In response to his loan plea, the lenders inform Mr. Jaiswal that they will need warrants for the loan. Being an unsecured loan option, Mr. Jaiswal has to agree to the conditions and requirements set by the lenders.

Subsequently, he avails a loan of Rs. 5 lakh by showing that he has an annual cash flow of Rs.3 lakh. Unfortunately, Mr. Jaiswal fails to pay within the pre-fixed term. Consequently, the lenders take a percentage of his fast food joint and sell it off to recover the loaned money. 

From this example, we gather that the risk of losing out a significant portion of the equity is high in the case of mezzanine capital. Business owners can avoid such risk by looking for alternative funding options like invoice discounting and fund their requirements easily. 

KredX helps businesses raise working capital at attractive terms and against their outstanding invoices. Get in touch with us now to learn more about our services!

    Frequently Asked Questions on Mezzanine Finance:

    A. The reason behind the name can be accredited to the risk aspect of this debt which lies midway between secured loans and venture equity. It resembles the mezzanine or intermediate floor structure between two others in a building.