Mezzanine debt offers several benefits including a larger amount of financing, longer terms, late payments, and the ability to retain control of the business. However, one clear advantage of mezzanine debt is the flexibility it offers borrowers. The mezzanine can be customized to the specific capital need you may have. This flexibility makes it a creative financing option for small and medium-sized businesses that have passed start-up status but don’t yet have the ability to finance large growth moves on their own or through traditional lending arrangements.
Mezzanine debt allows for greater flexibility through its highly flexible structures. Going for mezzanine debt offers a mid-market company custom solutions for structuring coupons, amortizations, and covenants that are tailored to the company’s specific cash flow requirements. It is best used when there is a need for additional capital follow-up, when subsequent acquisitions are part of the future growth plan.
Greater flexibility through mezzanine debt structures
In most intermediate agreements, the specific objectives of the company and the existing capital structure determine the type of structure that will be used. While the basic forms used in most mezzanine financings are subordinated notes and an additional return to the lender, a mezzanine transaction typically consists of any or a combination of the following options:
Cash interest: This involves a periodic cash payment based on a percentage of the outstanding balance of the mezzanine financing. This interest rate is generally fixed for the entire term of the loan,
Upfront Fees: This involves paying a closing fee to the mezzanine debt lender. This is usually in the range of 1% to 2% on the loan amount.
Upside Additional Return: Some, but not all, intermediary transactions involve a small return stimulus called a court order. This allows the lender to receive a small additional return based on the future performance of the business. This is in addition to the cash interest payment and PIK interest. The valuation methodology for this performance is clearly defined when the deal is closed. This additional repayment mechanism is helpful in aligning the interest of the business owner and the lender regarding the future value of the business.
PIK Interests: The abbreviated form of interest payable in kind, PIK, is a periodic payment form in which the interest payment is not paid in cash but by increasing the principal amount of the loan by the amount of the interest. The PIK interest amount is typically 2% and is added to the cash interest payment.
