Mezzanine capital

Mezzanine capital is a type of debt financing that combines elements of debt and equity. It is considered to be a hybrid form of financing that is typically used by companies to bridge gaps in funding. Mezzanine capital is usually used when a company has exhausted traditional financing options and needs additional capital to finance a project or expansion.

The features of mezzanine capital include:

• High Interest Rates: Mezzanine capital is usually offered with a higher interest rate than traditional debt. This is to compensate investors for the higher risk associated with it.
• Convertible to Equity: Mezzanine capital often comes with a clause that allows the debt to be converted to equity at a predetermined time or when certain conditions are met.
• Longer Term Financing: Mezzanine capital is usually offered with longer terms than traditional debt. This allows companies to spread out their payments over a longer period of time.

Overall, mezzanine capital is a hybrid form of financing that provides companies with additional capital and longer terms than traditional debt. It also comes with higher interest rates to compensate for the higher risk associated with it.

Example of Mezzanine capital

One example of mezzanine capital is the subordinated debt and warrants package offered by private equity firms. In this case, the private equity firm will provide the company with debt financing that is typically unsecured and subordinated to other creditors. In addition, the firm will also issue warrants that give the company the right to purchase shares of the company at a discounted price in the future.

The advantages of this type of mezzanine capital include access to capital, dilution protection for existing shareholders, and the ability to raise additional capital at a later date. On the other hand, it also carries risks such as the potential for dilution if the warrants are exercised, the subordination of the debt to other creditors, and the potential for the debt to be converted to equity at a later date.

When to use Mezzanine capital

Mezzanine capital is typically used when a company needs to bridge a gap between traditional financing options and the additional capital needed for a project or expansion. It is also used when a company needs to restructure its balance sheet or acquire another company.

Types of Mezzanine capital

Mezzanine capital can take on several different forms:

• Subordinated Debt: Subordinated debt is a type of mezzanine capital where the debt is subordinated to other creditors in the event of a default. This means that if a company defaults on its debt, the holders of the subordinated debt will not be paid until after all other creditors are paid.
• Preferred Stock: Preferred stock is a type of mezzanine capital where the company issues shares of stock that pay dividends at a fixed rate. These shares are similar to common stock, but they have a higher priority in the event of a default or liquidation.
• Equity Warrants: Equity warrants are a type of mezzanine capital where the company issues warrants to the investor that can be converted into shares of common stock at a predetermined price.

Advantages of Mezzanine capital

• Lower Cost than Equity: Mezzanine capital is typically cheaper than issuing additional equity. This allows companies to raise additional capital without diluting current shareholder value.
• Flexibility: Mezzanine capital offers companies the flexibility to structure the terms of the debt in ways that are more beneficial to them than traditional debt.
• Tax Benefits: The interest payments associated with mezzanine capital are typically tax deductible, which can help increase a company’s overall profitability.

Limitations of Mezzanine capital

• Dilution of Ownership: As mezzanine capital is convertible to equity, it can lead to the dilution of ownership if the debt is converted.
• Costly: As mezzanine capital typically comes with higher interest rates, it can be more costly than traditional debt.
• Repayment Risk: Companies may have difficulty repaying mezzanine capital if the project or expansion does not turn out as expected.

Other approaches related to Mezzanine capital

Equity-linked Notes: Equity-linked notes are debt instruments that are linked to the performance of an underlying asset, such as a stock index or a specific stock. These notes usually have a predetermined maturity date, and the investor's return is based on the performance of the underlying asset.

Subordinated Debt: Subordinated debt is a form of debt that has a lower priority than other types of debt. It is usually used by companies to obtain additional financing, and it typically has a higher interest rate than senior debt.

Preferred Stock: Preferred stock is a type of equity that has many of the same characteristics as debt. It typically pays a fixed dividend and has priority over common stock in the event of liquidation. Preferred stock is often used as a form of mezzanine capital.

Overall, there are several approaches related to mezzanine capital that companies can use to obtain additional capital. These approaches include equity-linked notes, subordinated debt, and preferred stock. Each of these approaches has its own advantages and disadvantages and should be carefully evaluated before making a decision.

Mezzanine capital — recommended articles

Hybrid instrument — Unsecured Note — Redeemable shares — Bonds in finance — Assets funding strategy — Cumulative Preferred Stock — Long-term debt — Capital dividend — Dividend Recapitalization

References

• Silbernagel, C., & Vaitkunas, D. (2012). Mezzanine finance. Bond Capital, 1-7.
• Vasilescu, L. G. (2010). Financing gap for SMEs and the mezzanine capital. Economic research-Ekonomska istraživanja, 23(3), 57-67.
• Dec, P., & Masiukiewicz, P. (2017). Mezzanine Capital as a Tool to Increase Enterprise Value in Crisis,". Business and Management Horizons, 5(1), 52-61.