Lenders provide mezzanine capital to borrowing companies that have a decent track record in their industry. Since mezzanine capital is a form of convertible debt, it can be converted into equity in case the borrower is not able to make payments on time. This type of debt is usually offered by lenders when organizations can prove they have promising plans for their company.
Mezzanine debt is usually converted into equity when venture capitalists and other senior leaders have been paid-off. There is no collateral required in this type of financing. However, this facility is usually considered as a high-risk high-return loan. Therefore, interest rates usually revolve around 10% to 20%.
Leveraging on Mezzanine financing
Consider a private equity firm that is willing to purchase a $300 Million company. The leadership can accumulate $270 Million from their investors. However, they are running short of $30 Million. The private equity firm can take leverage of mezzanine financing by borrowing this capital from a financial institution and minimizing their risk in the overall deal structure.
Advantages of acquiring mezzanine debt
- One of the significant benefits of mezzanine financing is that they are tax deductible. This means that whatever interest payment you make on this facility can be deducted from your tax payments.
- It allows growing organizations to avail long-term loans from financial institutions based on their expansion plans. The borrower, on the other hand, has an advantage of gaining equity in the company in case the client defaults on the loan.
- Another great benefit of securing a mezzanine debt is the lender has minimal or no influence on the company operations. This helps the board of director and senior management to be in control of the business at all times.
Effect of Mezzanine debt on STOs
STOs or Security Token Offerings are a nascent way for companies to raise growth capital through blockchain platform. When they were first introduced a couple of years back, STOs were seen as a big threat to mezzanine capital. However, with time, investors and borrowers realize that this type of security is too new to be considered reliable.
One of the primary reasons for this shift of trust from STOs to mezzanine debt is that the blockchain market is still quite unregulated. The fear that regulators may jump in any time to ensure compliance in the digital currency marketplace is discouraging organizations to raise STO based funding.
Finally, STO transactions will require borrowing companies and investors to put in place digital security measure to manage and transact tokens online. This would make them vulnerable to hacking attacks.
Mezzanine debt is a great way for small businesses and established corporate organizations to raise capital for their long-term growth. If companies can prove that they have the right management with a proper action plan for future growth, they should not have much trouble raising mezzanine capital from banks and other financial institutions.