Should you be considering a mezzanine loan?

mezzanine loan

Business owners can’t predict the future—much less control it.

COVID-19 has brought rapid and dramatic change to the business landscape. Many companies have lost revenue due to the pandemic. Others need capital to take advantage of new business opportunities.

Even though you can’t predict the future, you can still be informed about the range of financial options available to your business. One such option is a mezzanine loan. Mezzanine loans offer quick access to capital in exchange for slightly higher interest rates and a specific set of restrictions. 

Understanding this tool will help you make savvy decisions about what is best for you and for your company—in both good economic times and bad ones. 

What is a mezzanine loan?

Mezzanine financing layers a junior loan on top of a primary loan by combining secured debt from a bank with equity-based financing obtained from direct investors. These loans can be offered by private equity groups, mutual funds, insurance companies, and buyout firms.

Because mezzanine debt is unsecured or has liens subordinate to other lenders, the cost of obtaining mezzanine financing is higher than that of obtaining a senior loan, but still lower than the cost of obtaining funding purely from equity investment. Generally, the lower your interest rate, the more equity you must offer. 

Risks and rewards

So why would a business choose a more expensive loan? 

Mezzanine financing can provide capital that is difficult to obtain elsewhere. For this reason, these loans are often used as a “bridge” towards a specific objective like acquiring another business or a piece of commercial property. Additionally, many companies seek out mezzanine loans for their flexible terms. 

These loans may also come with additional stipulations. Most mezzanine financing instruments allow the lender to participate in a company’s success or failure, and lenders may retain the right to have a say in business operations. Additionally, if a business defaults on its loan, the lender has the right to sell to transfer their equity, which could leave you with a brand new co-owner. 

Mezzanine financing can complicate mergers and acquisitions by introducing an extra party to the negotiation table. 

Should I pursue a mezzanine loan?

Generally, mezzanine loans are best suited for businesses with clear and even aggressive growth plans. A trusted Smolin accountant can aid your decision by helping you explore the tax, financial and strategic implications of a lending arrangement.