Getting Knowledgeable About The Mezzanine Capital Concept In Business Funding
Funding a business is not easy not only because of its continual need for cash but also for the fact that a proper source is hard to find, even if there are so many to choose from. However, selecting a suitable source may be possible with thorough research but the type of loan to take can be a very hard decision to make.
- This is primarily because there are too many different types to choose from and each of these types have characteristics features and attributes of its own.
- Moreover, each of these loan types comes with its own merits and demerits which most of the business owners either fail to understand or ignore completely while taking out a loan.
As a result, they end up in taking on a loan much more than they can afford or need to borrow. This affects s lot of areas of their business such as:
- Their finance management
- Debt conditions
- Cash flow
- Credit score and eventually
- Their business operation, sustenance and growth.
If you do want such a thing to happen to your business you will need to follow a completely different and unique approach to choose a lender and a loan to fund your business.
You must first put yourself in the place of the money lender for a moment. What is the thing that the lender is looking for? Of course, it is the best value in return for the money they want to invest in you. they will relate this return to the risks associated in making such a loan and certainly want it to be at the minimum, if not at all.
This is the usual behavior and concern for all moneylenders whether it is a traditional commercial bank or any private money lender, a non-banking financial organization or any online lending sources such as Libertylending.com.
Problem with standard business financing methods
Typically, there are two methods commonly followed by business owners to raise their required capital. These are debt financing and equity financing. Common as these may, there are problems with both these types of business funding.
- The most common problem with debt financing for the business owners is that there is a high chance of accumulation of credit risks.
- On the other hand, for the lenders the problem is that they do not get a share of the business success, profit, ownership and control just as the investors making equity financing usually get.
That means, the lender in debt financing only gets the money back that it loaned to the business along with an interest for sacrificing the alternate use of the money and taking the risk of default and non-payment while lending the money to you.
This added amount of money they receive as interest on the loan is not at all an impressive return to their investment by any means or standards as compared to the amount of risks that undertake while making the loan. This rate of interest mostly offers a single-digit return.
Concept of mezzanine capital
In order to ensure that the lenders do get a handsome return on their investments, in comes the concept of mezzanine capital. This is in fact a combination of some of the best features of debt and equity financing.
In this specific type of lending, there is no specifically set structure but still this type of business financing is very beneficial for the lenders. This is because it gives the lenders or the lending institutions the authority to convert the loan into an equity interest from simply a debt capital.
That means they can now enjoy the same benefits as the equity investors in your company if you fail to repay the loan on time or do not pay it off in full.
Advantages of mezzanine capital
The concept of mezzanine capital has a lot of inherent advantages for the lenders as well as the borrowers including the following:
- This is the best possible financing option for a new company that is showing some growth prospects already
- This concept provides the banks with an additional safety net making it easier for them to get back their loan
- The company can treat this mezzanine capital as an equity in the balance sheet rather than a debt obligation
- It makes the companies balance sheet look more attractive and stronger to the future lenders making it easier for them to lend and for the company to get their desired funds.
Most importantly, mezzanine capital is often provided to the borrowers with very little due diligence making it a much quicker option than other traditional loans.
Disadvantages of mezzanine capital
Much like other loans, mezzanine capital also comes with its own share of disadvantages as well. The list includes:
- The interest, commonly known as coupon, is often higher because the lender considers the business as high risk
- This type of capital when provided to a business that have debt or equity obligations already is often subsidiary to those obligations
- This increases the risk of the lender not being repaid the loan amount.
That means that just as it is in equity capital, the potential risk of losing a considerable part of the company is much real and existing in mezzanine capital concept.
It is due to all these risks involved the lender of the mezzanine loan will often want to see a potential return from the business as high as 20 to 30%. It is therefore required for you to note at this point that mezzanine capital is not as standard as equity or debt financing. This is because the deal as well as the reward or risks involved in it will be party specific and therefore vary from one business to another.
The final thoughts
When you do not have any friend or family to finance your business or you want to avoid financing your business from any formal source you may consider debt financing. This is likely to provide your business with more advantages. As and when your business grows, consider equity financing or mezzanine capital as a suitable option.