vcapital posted on June 07, 2011 20:57
Financing: It's micro lending for businesses
Mezzanine funding can be a company’s best bet
Jun 4, 2011 12:03 PM | Times Live: By TINA WEAVIND
Money lending is probably the second-oldest profession. And it appears in many wildly creative formats. When it comes to really big numbers - such as those involved in businesses - creativity and flexibility are hugely sought-after attributes.
The two most common ways for businesses to raise money is through debt (borrowing) or through equity (selling off small parts of the business).
But what if you've created a brilliant new social networking site that you know will print money in a few years' time if you could only hire a team of top-notch programmers to get you on track? The debt and equity options are going to prove pretty tricky: the banks won't look at you because you've got no assets to attach if your company goes south, and you don't really have a company to sell equity in. So you turn to a mezzanine financer and you customise a repayment contract that works for both of you.
Mezzanine funding is so called because it occupies the space between debt and equity in terms of risk. On one end of the scale is debt which has the lowest risk - the bank that lends you money will attach your assets if you can't pay it back. Equity, on the opposite end, has the highest risk - sorry for you if the company you've invested in goes south.
Mezzanine funding is a "subordinated debt" because it falls below ordinary debt in the risk hierarchy, but it is ahead of equity holders in the queue if the business goes bang.
To make up for this risk level, mezzanine funding typically has a high rate of interest - often between 20% and 30%. It's a price companies are willing to pay because the loans are usually given quickly and with a minimum of due diligence.
As Andrew Abdo, director of Atco, says, there's an uncanny resemblance to micro lending in the business model. Only they don't break your kneecaps if you can't make your payments.
As well as charging a premium interest rate, the loan can be converted from a debt into equity if the company can't meet its repayment deadlines on time or in full. In other words, if they don't get their payments, the financing company can take over part or all of the company .
Presuming the company has a positive track record, or for some other reason the mezzanine financiers have faith in its future, this kind of funding creates a win-win situation.
The financiers are covered by high interest rates and potential ownership of the company, and the borrowers get their funding quickly and with minimal hassle. The terms of repayment are widely adaptable to each scenario. The start time for repayments might vary, and there might be various payment-in-kind clauses built in as well as the potential for debt to equity conversion.
Mezzanine financing is often used to expand existing companies or to fund leveraged buyouts. It's also common where management wants to buy back shares from private equity investors. It's typically used in BEE deals and where ordinary debt finance is difficult to get.
Locally, mezzanine finance is provided by investment banks, hedge funds and private equity fund managers.