While a Mezzanine loan is much more complex than the standard types of funding, in some cases, it can be quite useful. If you run a business, real estate related or otherwise, then you should make sure that you at least understand all of the options available to you, and while you may not opt to go for Mezzanine funding, you should still have a basic understanding of it.
So, in this article, we’ll be talking about Mezzanine loans. We’ll explain what they are, how they’re structured, and we’ll talk about the benefits of this funding type. This should give you a good understanding of the process and allow you to decide whether a Mezzanine loan is right for you.
What is a Mezzanine loan?
You are likely already familiar with debt and equity financing, but you may be less familiar with Mezzanine financing, which lands somewhere in the middle. This confusing, yet useful funding option can provide you flexible financing without losing your equity.
While debt financing, such as what you’d see with a commercial property mortgage, operates on the basis that the lender will be recovering their investment via a monthly payment and interest, and equity financing requires that the financer take on a huge sum of risk by investing in the project itself, the Mezzanine loan offers a happy medium. Escrow on residential can close within 21 days. Due to higher risk of Mezanine loans, it may take longer than what typical residential mortage loans take.
While the exact arrangement can vary based on what the parties involved agree on, in general, it offers both the risk and reward aspect of an equity investment, while offering the predictable return of a debt financing agreement.
That’s because with a Mezzanine loan you will still be paying interest to the lender, but the terms will be much more flexible. The lender will also have the option of obtaining equity in your project, either as a guarantee should you default on your loan, or as a bonus later should the terms allow for it.
What are the benefits of a Mezzanine loan?
While a Mezzanine loan is not right for every occasion, it does have some distinct benefits over other loan types. We’ve already discussed how that for the lender, these loans are often more reliable in terms of repayment and balancing risk and reward, but what about for the borrower?
For the borrower, a Mezzanine loan is often a good way to secure funding if you are lacking in collateral. It’s also very flexible, and it can offer repayment schedules which may better suit the needs of your project.
This includes the ability to roll interest payments into the loan’s balance if you don’t have the funds to pay up at that particular time, something that traditional funding just doesn’t offer.
Quick growing projects often also enjoy the fact that the loan interest is tax deductible, and that they can often refinance rather quickly, moving that debt into a standard loan type that carries a more attractive interest rate.
However, having Mezzanine investors onboard your project can also open doors for other more traditional funding options. Mezzanine lenders are long-term investors, and this looks good to creditors, who will then extend you further credit in other ways.
What are the Disadvantages of a Mezzanine loan?
Every funding type has downsides, and for a Mezzanine loan, you have to look out for many things before signing on the dotted line. For starters, this may not be the most cost-effective way to secure your financing, and you may end up paying a hefty premium for the privilege of flexibility.
Lenders can also be incredibly picky with their requirements, and a deal like this may take several months to set up, so proceed with caution. There is also usually a stipulation which allows you to lose control of the project, at least in part, if things go south.
How are Mezzanine loans structured?
While the structure of these loans can vary, the most common structure of a Mezzanine loan goes something like this.
Let’s say that an investor offers you mezzanine financing for commercial property development. You gain flexible lending, which allows you to expand and build more units, on top of what your traditional lender has offered.
The investor is then promised 10% per year in interest payments for the loan, and if you default, then this will convert to an equity interest. However, in some cases, they can also be offered an option to purchase equity at a later date, or other scenarios as agreed upon.
Keep in mind that Mezzanine loans are typically quite large, and you’ll most likely be looking at a funding amount of around $10 million before anyone will bother to sign a deal like this with you. While in some cases, you may find someone willing to do it for $2-5 million, these deals are normally too expensive to be worthwhile.
When should you consider using Mezzanine funding?
In most cases, Mezzanine funding will not be the main funding for a project. Instead, they are typically used as a means to squeeze out more funding from additional avenues. You could think of them as part of your funding stack rather than your primary source of financing.
Mezzanine funding is a popular choice for acquiring capital for growth, such as for the construction of new facilities or properties. Or, it’s often also utilized for shareholder buyouts, acquisitions, and refinancing opportunities.
In closing, Mezzanine funding is complicated, and you should make sure that you have the appropriate legal help if you want to go through with this type of deal. It’s not for everyone, and it certainly is not something to approach without full knowledge of the subject.
While there are plenty of reasons to use Mezzanine financing options, there are also plenty of cons which you should be afraid of. If you’re not careful, then you could end up making a costly mistake.
This article is intended to provide you with a basic understanding of the process, but there’s a lot more to learn about Mezzanine loans before you jump in with both feet.