Flexible financing with mezzanine debt

Intermediate debt offers several benefits including increased financing, longer terms, late payments, and the ability to maintain control over the business. However, a clear advantage of intermediate debt is the flexibility it offers to borrowers. The mezzanine can be customized based on the specific capital need you may have. This flexibility makes it a creative financing option for small and medium-sized businesses that have passed the start-up stage but still do not have the ability to finance large growth movements on their own or through traditional loan agreements.

Mezzanine debt allows for greater flexibility through its highly flexible structures. Opting for mezzanine debt provides a mid-market company with customized solutions for structuring coupons, amortizations and agreements that are tailored to the specific cash flow requirements of the company. It is best used when there is a subsequent need for additional capital, when subsequent acquisitions are part of the future growth plan.

Greater flexibility through mezzanine debt structures

In most mezzanine arrangements, the specific objectives of the business and the existing capital structure in place determine the type of structure to be used. While the basic forms used in most mezzanine financing are subordinate notes and an added benefit to the lender, a mezzanine agreement is generally made up of one or a combination of the following:

Interest in cash: This involves a periodic cash payment based on a percentage of the outstanding balance of the mezzanine financing. This interest rate is usually set for the entire term of the loan.

Upfront fees: This involves paying a closing fee to the mezzanine debt lender. It is generally in the range of 1% to 2% of the loan amount.

Additional return to the upside: Some, but not all, mezzanine agreements involve a small payback 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 payment of cash interest and PIK interest. The valuation methodology for this profitability is clearly defined when the transaction is closed. This additional return mechanism is helpful in aligning the interests of the business owner and the lender in the future value of the business.

PIK interest: The short form of interest payable in kind, PIK, is a form of periodic payment in which the interest payment is not paid in cash, but instead increases the principal amount of the loan by the amount of interest. The PIK interest amount is usually 2% and is in addition to the interest payment in cash.