Mezzanine Capital
Definition of Mezzanine Capital
The term “mezzanine” originates from architecture; in Italian, it refers to a “mezzanine floor.” Mezzanine capital is a general term used to describe types of financing that occupy an intermediate position between traditional equity and debt. For this reason, mezzanine capital is also referred to as hybrid capital. Whether it is classified more as equity or debt in a given case is determined by the specific terms of the financing agreement.
In practice, the most common forms of mezzanine financing are: shareholder loans, (profit-participating) subordinated loans, silent partnerships, profit participation rights, profit participation certificates, convertible loans, and convertible and option bonds.
Subordination of Mezzanine Capital
An important aspect of mezzanine capital is its subordinated status relative to debt. In the event of insolvency, mezzanine capital providers are repaid only after all senior creditors have been satisfied. Even though mezzanine capital is usually classified as debt on the balance sheet, its subordinate status gives it an equity-like character, and it is recognized as economic equity.
Advantages from the Company’s Perspective
Improved equity ratio:
By obtaining mezzanine capital, a company can strengthen its equity—since the mezzanine debt is subordinated to third-party creditors—thereby improving its balance sheet structure as well as its creditworthiness and credit rating. This reduces the cost of new debt financing.
Flexibility:
The structuring options for mezzanine capital are so varied that flexible financing solutions are possible; in particular, there is significant leeway regarding terms, termination options, interest, profit, and loss provisions, and repayment terms.
Limited Voting Rights:
When obtaining mezzanine capital, companies typically do not cede voting rights to the investors; thus, the existing ownership structure can be preserved while still strengthening the company’s equity position.
Tax advantages:
Companies can claim the payments made for the provision of mezzanine capital as financing costs for tax purposes, thereby reducing their taxable income.
No Collateral Required:
Investors often do not require collateral in exchange for providing mezzanine capital.
Reduced Dependence:
Mezzanine capital can be provided without involving banks. Companies can thus reduce their dependence on financial institutions.
Disadvantages from the company’s perspective
High financing costs:
Typically, the costs of mezzanine capital are significantly higher than those of traditional debt.
Sometimes lengthy decision-making process:
The processing time until final approval of mezzanine financing is often very long, as investors conduct extensive risk assessments.
Repayment obligation:
Unlike true equity, mezzanine capital is provided only for a limited period and must be repaid in full at the end of the term.
Stable cash flow:
In order to service the regular payments on mezzanine financing as agreed, the financed company must have a stable cash flow.
Potential Lenders
There are various sources of mezzanine capital; companies seeking mezzanine financing can primarily turn to private investors, banks, insurance companies, private equity firms, venture capital firms, or specialized mezzanine funds. The amount of financing available depends largely on the company to be financed and the planned use of capital. Minimum amounts are often between approximately one and five million euros. However, some companies or banks also offer mezzanine products starting as low as 50,000, for example, for growth and innovation financing.
Practical Application
Mezzanine capital can be structured flexibly to meet the specific needs of the company being financed, complementing both equity and debt capital. Mezzanine capital can be an attractive financing option, particularly for young companies with high investment needs. If young companies have neither sufficient equity nor a strong enough credit rating, mezzanine capital can either be used to increase economic equity and improve the credit rating or to directly finance investments.
Established companies can use mezzanine capital to improve their equity ratio, which can lead to more favorable loan terms and higher financing amounts from banks. Mezzanine capital can make a positive contribution here, particularly when there is a larger overall financing need. Given the complex range of possibilities and aspects involved in mezzanine financing, the advantages and disadvantages for the company should always be weighed on a case-by-case basis.