Mezzanine Financing: How It Works and How You Can Use It

Since the great recession, lenders have tightened their qualification processes for commercial real estate and raised their income and asset thresholds considerably, leading to an access shortfall that is affecting investors and small business communities across the country. The effects of it have ranged from limiting the size of loans in ways that produce funding shortfalls to the outright rejection of people who would once have been viewed as strong candidates for loan instruments. As these requirements have tightened, alternative funding methods that bridge the gap for companies have emerged, and mezzanine financing stands out as one of the more promising solutions among them.

The first step toward understanding how mezzanine funding works for you is just understanding how it works. The goal of this kind of funding is to bridge the gap between senior debt and sponsor equity, making it flexible in its definitions and allowing the structure of individual funds to be set up to meet the needs of the borrower. Regardless of the actual split, the defining feature of this kind of financing is the combination of interest-bearing debt and investment equity.

Typically, investors have a target number for overall ROI that they are seeking, and they work with companies that need funding to provide their support as a combination of debt and investment designed to produce the yield they need in a way that fits your business. It is also common for mezzanine financing arrangements to contain stipulations that returns on the equity investment will not be attainable until all senior debt is satisfied, to protect other forms of debt owed by the company and to ensure its long-term success. This makes mezzanine investment slightly riskier than regular debt for investors, but not as risky as a full equity sponsorship.

As an entrepreneur seeking funding, mezzanine structures present a few great opportunities. It allows you to reach beyond your friends and family network in order to access investors that you otherwise might not be able to recruit as backers. It also presents those investors with a way to mitigate the risk they might otherwise take. On the other side, for entrepreneurs looking to avoid excess dilution of their own investments, mezzanine funds present the opportunity to gain the funding needed without sacrificing large amounts of equity. Either way, they provide business owners with the opportunity to bridge the gap between their own capital investment and the availability of traditional loan financing in ways that other financial products do not.

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