If you are raising growth capital to expand your business, you may want to consider using mezzanine financing as part of your financing solution.

Mezzanine financing is a form of debt that can be a great tool for financing specific initiatives like plant expansions or launching new product lines, as well as other major strategic initiatives like buying a business partner, making an acquisition, financing dividend payment from a shareholder or completing a financial restructuring to reduce debt payments.

It is commonly used in combination with bank-provided term loans, revolving lines of credit, and equity financing, or can be used as a substitute for bank debt and equity financing.

This type of capital is considered “junior” capital in terms of its payment priority to senior secured debt, but is senior to the company’s equity or common stock. In a capital structure, it is below principal bank debt, but above equity capital.

Advantages:

1. Mezzanine financing lenders are focused on cash flow, not collateral: These lenders typically lend based on a company’s cash flow, not collateral (assets), so they will often lend money when banks won’t if a company lacks tangible collateral, as long as the company has sufficient cash flow. Cash available to pay interest and principal payments.
2. It is a cheaper financing option than increasing capital: Pricing is less expensive than raising capital from equity investors such as family offices, venture capital firms, or private equity firms, which means owners forgo less, if any, additional capital to finance their growth.
3. Flexible Capital, Not Amortizable: No immediate principal payments – This is typically just interest principal with a balloon payment due at maturity, allowing the borrower to take cash that would have gone toward making principal payments and reinvest it back into the business.
4. Long-Term Capital: It typically has a maturity of five years or more, making it a long-term financing option that won’t have to be repaid any time soon; it is generally not used as a bridge loan.
5. Current owners retain control: It does not require a change in ownership or control: existing owners and shareholders maintain control, a key difference between getting mezzanine financing and raising capital from a private equity firm.

cons

1. More expensive than bank debt: Since junior capital is often unsecured and subordinated to senior loans provided by banks, and is inherently a riskier loan, it is more expensive than bank debt.
2. Warranties may include: By taking on more risk than most secured lenders, mezzanine lenders will often seek to share in the success of those they lend money to and may include guarantees that allow them to increase their return if a borrower performs very well.

When to use it

Common situations include:

• Finance rapid organic growth or new growth initiatives

• Financing of new acquisitions

• Purchase from a business partner or shareholder

• Generational transfers: source of capital that allows a family member to provide liquidity to the current entrepreneur

• Shareholder liquidity: financing the payment of a dividend to shareholders

• Financing of new leveraged buyouts and management buyouts.

Great capital option for service companies or asset light

Since the tendency of mezzanine lenders is to lend against a company’s cash flow, not the collateral, mezzanine financing is an excellent solution for financing service businesses, such as logistics companies, personnel companies, and software companies, although it can also be a great solution for manufacturers. or distributors, who often have many assets.

What these lenders are looking for

While no business financing option is right for every situation, here are some attributes cash flow lenders look for when evaluating new business:

• Limited customer concentration

• Consistent or growing cash flow profile

• High free cash flow margins – strong gross margins, low capex requirements

• Strong management team

• Low business cyclicality which could result in volatile cash flows from year to year

• Abundant cash flow to support interest and principal payments

• An enterprise value of the company well above the level of debt

Nonbank Growth Capital Option

As bank lenders face increased regulation on tangible collateral coverage requirements and leveraged loan limits, the use of alternative financing, particularly in the middle market, is likely to increase, filling the capital gap for lenders. business owners seeking funds to grow.