How Does Mezzanine Financing Work?

Not all financing options fall under the linear categories of debt or equity-based. A third type of financing is a hybrid that combines elements of both debt and equity-based financing. Mezzanine financing, for instance, is one such hybrid option for business owners to consider. So, how does mezzanine financing work, and is right for your business?

How Does Mezzanine Financing Work?

Mezzanine Financing: The Basics

Mezzanine financing is a type of loan that grants the lender authority to convert the security into equity (ownership) at a fixed price for share if the borrower fails to pay or otherwise meet the loan’s obligations. If a business owners acquires a mezzanine loan, for instance, and later defaults on it, the lender can convert the security into equity; thus, minimizing the risk for the lender.

Advantages of Mezzanine Financing

There are several advantages to using mezzanine financing, one of which is the simple fact that the interest is tax-deductible. Any interest paid on a mezzanine loan can be deducted from the borrower’s taxes, helping to offset the costs of other expenses. Mezzanine financing is also said to be easier to manage than other financing options because the interest can be calculated into the loan’s total balance. Furthermore, a portion of the loan’s interest may be deferred if the borrower cannot make a payment.

Because it’s backed by equity, however, mezzanine loans are easier to acquire than conventional debt-based loans. Lenders know that if the borrower doesn’t pay back the loan, they can secure equity in the borrower’s company.

Disadvantages of Mezzanine Financing

On the other hand, borrowers of mezzanine financing risk forfeiting partial ownership of their company in the event they are unable to pay it back.

Additionally, interest rates can be relatively high for mezzanine financing compared to other options. It’s not uncommon for borrowers to pay anywhere from 10% to 20% interest on a mezzanine loan. As stated above, however, that interest is tax-deductible.

The Bottom Line

Mezzanine financing is a hybrid loan that combines elements of both debt and equity-based financing. It gives the borrower the right to convert security into equity if the borrower fails to meet the repayment obligations. Though it carries a high interest rate, mezzanine financing is easier to obtain than conventional financing.

This article was brought to you by Intrepid Private Capital�Group � A Global Financial Services Company. For more information on startup and business funding, please visit our website.