Mezzanine funding is a type of junior capital between senior debt financing and equity. In short, a means that companies can access capital from. Let’s understand its features in detail.
Mezzanine funding can either be defined as a portion of the savings given by private equity, and taking further loans from multiple investors to provide funds for the purchase; or it can be categorized as private equity that come from company’s own savings and then they further take debt from the company itself to arrange the funding. Hence, in this type of funding there is a risk factor, which is much higher and the expectation of benefits is also high.
To understand the significance and basic characteristics of this type of funding, here are some basics related to the concept of Mezzanine Funding:
Mezzanine financing is a mix of debt and equity financing that gives the lender a right to convert it to an equity interest in the company mostly when the capital companies and other senior lenders have already been paid.
Mezzanine debt consists of equity instruments also known as warrants, which increases the value of the other debts and increases the flexibility while dealing with the bondholders. Moreover, Mezzanine funding is associated with acquisitions and buyouts, this can be used to give priority to the new owners before the existing owners, especially in case of bankruptcy.
Mezzanine funding in India primarily bridges the gap between debt and equity financing as it is one of the highest-risk forms of debt. In simple words, it is superior to pure equity but inferior to pure debt. However, this type of funding is considered promising as it has the capacity to offer highest returns in relation to other debt types. Usually, the rate of interest it receives is between 12% to 20% per year, and at times it can reach upto 30%.
Hence, most of the companies use mezzanine funding in order to provide funds for the growth projects or to help with acquisitions for short and medium time duration. Most of the time, these loans are provided by long-term investors.
Mezzanine funding involves risk and hence, usually taken ahead by the large investors. Here are some benefits of Mezzanine Funding that you should know about:
To understand Mezzanine funds practically, you must understand that it can be used for buying a company or for expanding one’s own business without going for an IPO.
For instance, Mr. Vats owns an ice-cream parlor and he is planning to expand his business. But he is willing to follow the unconventional way of equity financing. Therefore, he chooses mezzanine financing and asks mezzanine financiers for mezzanine loans. This means that now the lenders would need warrants or options for the mezzanine loans as the loans are unsecured. For this, Mr. Vats is bound to agree to the terms asked by the mezzanine lenders.
So, after agreeing upon the conditions, Mr Vats takes Rs.10,00,000 against his annual cash flow of Rs. 1,00,000. This is to for the assurance of the lender, supposedly if Mr Vats is unable to pay back the amount at the time of payment due to some unfavourable conditions in the business, then the lenders will acquire a portion of Mr. Vats’ ice-cream parlor and would be eligible to sell it off in order to get the loan amount.
Likewise in 2016, Olympus Partners, a private equity firm in Conn. was funded by Antares Capital to acquire AmSpec Holding Corp, a company that offered inspection, and certification services for petroleum traders.
As the total amount was $215 million, that also included a revolving credit facility, a term loan, and a delayed draw term loan. Antares Capital offered the total capital in the form of mezzanine debt, which acted as an equity option.
India's leading Private Equity firm, ICICI Venture's 'India Advantage Fund VII' offered $110 million in its first round of fund raising, half of it was committed by limited partners. And the fund is one of the single largest country-based mezzanine fund in the emerging markets of Asia. Moreover, Franklin Templeton Investments' Private Equity firm - Darby Overseas Investments has launched the Darby Asia Mezzanine Fund II, that received institutional commitments of $300 million and committed investments with the affiliation of Faridabad based ‘Escorts Construction Equipment’. Since mezzanine funds contain debt, or debt-like instruments, the ones who receive the capital investment have to make interest payments, in order to generate significant current income for investors.
In addition to the above points, Mezzanine Funding Services in India are selected if they can be a strong partner that understands the company goals and can prove to be a supportive source for a long-term. For both expensive debt and cheap equity, mezzanine funding is a reliable option for companies who are looking for additional capital and cannot afford to sell or lose control.