Mezzanine debt: How does that work?
There are currently numerous financing methods to accompany the growth of companies.
Among these, there is an investment for mezzanine debt, a source of financing that is of particular interest to SMEs.
Debt mezzanine: what exactly is it about?
Nicknamed also « junior debt », the mezzanine debt is a subordinated debt the repayment of a bank debt said « senior debt ». In other words, your reimbursement can not occur while the senior debt is not paid in full. It is characterized by a duration comprised between 8 and 10 years.
A funding tool « Mezzo-soprano »
You have to know that the term « entresuelo » is derived from Italian « mezzo-soprano », meaning « in the middle ». Mezzanine financing thus presents an intermediary character between the investment in own funds and classic (senior) debt.
Noting that the mezzanine debt holders are called the « mezzaneurs ».
In which situations do you resort to the mezzanine debt?
This mode of financing can be used in 2 main cases:
For the financing of a strong growing society
Instead of opting for a strengthening of own funds, the company decides to establish a slice of reimbursable mezzanine term. This will allow you to transfer the demand for financing in capital and optimize the dilution for the partners.
In the framework of a financial assembly of type LBO
On the occasion of an acquisition of a company via an assembly LBO (Leverage Buy-Out), the promoters of the project integrate a mezzanine slice between senior capital and debt. This will allow the financial incentive to increase little by increasing the profit of the shareholders on their own funds.
How is a mezzanine debt presented?
As it has already been said before, the mezzanine debt is a form of intermediary financing. From this fact, it consists of two investment devices :
- Financing for debt that is made by the circumvention of the obligations (securities that are presented in the form of a loan).
- The financing by capital that is produced through shares (titles that represent a fraction of the company’s capital stock).
In addition, it can be presented in different ways :
- Combined bank credit for stock subscription bonds
- Issuance of Obligations with Share Subscription Bonds (OBSA)
- Issuance of Convertible Obligations in Shares (OCA)
Debt mezzanine: what advantages can we throw it?
Mezzanine debt is a very advantageous hybrid financing method. And with good reason, it leaves the newly created company or the holding company the time to develop. As he resorts primarily to the sum of the mezzanine financing, he is able to keep his capital intact.
Another advantage of the mezzanine debt: it accentuates the leverage effect. In effect, your reimbursement is in short, which allows the company to grow and develop before the due date of the debt. It also allows for a « customized » financial assembly for society. Total, represents a very flexible mode of financing.
It also offers the possibility of enjoying a longer duration of indebtedness than that of a classic loan. In addition, it allows the company to take advantage of a greater flexibility in terms of target management. This is possible on the other hand thanks to the weak restriction of the covenants.
On the other hand, this « junior » debt allows the company to have more freedom. The mezzanine investor effectively has only a limited right of co-management. The same, occupies a seat only temporarily in the board of directors.
In addition to filling gaps in funding, it also allows improving the solvency of society. What is more, it is in a position to strengthen the structure of the balance sheet by providing a more flexible remuneration. In fact, it allows to subtract the interests of the taxes.
The drawbacks of the mezzanine financing
Mezzanine debt financing, however, presents risks that should not be neglected at the time of financial assembly. Indeed, in relation to classical financing by credit, generates higher couts. Because it imposes a greater transparency. In addition, unlike the « pure » own funds, the funds put at the disposal of the company have a limited duration.
The risk also exists in case the results counted would not be in the appointment. For the holder of the debt, a non-repayment risk has to be feared if the senior debt is not fully paid when due. For shareholders, instead of the expected leverage effect, a chisel effect has to fear.
The reimbursement of the mezzanine debt
Mezzanine financing is reimbursed in short, that is, when the bank loan is paid. Thus, at the end of the operation, two alternatives are offered to the mezzaneur :
The company repays its loan upon maturity of the obligations.
Get shares of the company that follow the conditions defined at the time of the assembly of the financing.
Know that the course of the shares acquired by the mezzaneur is fixed upon the assembly of the operation. But, at the end of the operation, the choice returns to you as to the form of your refund.
Mezzanine debt: a very different tool from crowdlending
Although the loan in short of a crowdlending is close to that of a mezzanine debt, these two modes of financing are not comparable. And rightly so, the mezzanine financing proposes expirations (8 – 10 years in the end) that distinctly surpass those requested in the framework of a crowdlending. On the other hand, for a project to acquire a company, the mezzanine is the most appropriate tool.
In addition, it is more adapted to a private equity operation and a more complex financial assembly.