Why Mezzanine Loan Is an Effective Way of Funding Your Business Expansion Plans
A mezzanine loan is a type of non-traditional financing availed by businesses for specific needs, such as funding a critical project or acquisition. It is unlikely that they can get funding from traditional sources for such purposes. In such cases, the mezzanine loan can come to their rescue.
Mezzanine funding is a kind of alternative funding. It is typically availed by companies with an impressive track record of growth and looking to expand further. Unless they have access to funds to support their expansion plans, they will not be able to grow at the pace they desire.
Why Choose Mezzanine Loan
Suppose you are a company ready to extend your areas of operation to a broader market or need funding to acquire a company that will help you gain market leadership. In that case, mezzanine funds can be the best option. You must note that mezzanine loans are expensive as they come at a higher cost than traditional loans. Interest rates are high in this type of alternative lending, which may affect the future financial management of the organization.
The Pros and Cons
There are pros and cons of funding your business needs using mezzanine loans.
- You get quick and easy access to the capital needed
- It minimizes equity dilution
- Interest payments are deductible
- There are various repayment options available
- It can benefit the capital structure of your organization
- There are significant financial consequences if repayment terms are not followed
- There is a risk of equity loss
- You may have to share control of your business with the lenders
How It Benefits Lenders
Mezzanine loans are one of the unique funding solutions available for growing businesses. If you cannot make repayment and the process comes to asset liquidation, the mezzanine lenders are just behind the banks and other secured lenders. Mezzanine loans are unlikely to cause problems for the banks of the borrowing company as the lender has lower priority if there is liquidation. Also, they cannot stake a claim on any of the collateral offered for secured loans.
Lenders often add some kind of equity warrants to the mezzanine loans to minimize the risk of this instrument. These warrants allow the lenders to have a stake in the company borrowing the funds. In some cases, they also get legal rights to potential equity value.
What Are Warrants
Warrants are options that allow lenders to buy a specific quantity of shares at a fixed price on a specific date. They are designed to provide them with the opportunity to boost potential return on investment. This can be achieved without the borrowers losing any substantial equity. While ensuring that the loan remains flexible, warrants also make it easy for lenders to think positively about the progress of the company and its future profitability. It helps create a mutually respected and beneficial association that works to the advantage of all concerned parties.
A mezzanine loan is an easy funding opportunity for businesses looking for short-term financing to cater to specific business expansion needs. Given the high rate of interest, most companies make it a priority to pay back the loan over other borrowings.