Mezzanine capital is a part of the world of financing that deals with subordinated debt, or is considered as a preferred equity instrument that holds claims on the assets of a company. Mezzanine capital is an expensive source of financing as opposed to secured debt or senior debt.
Additionally, mezzanine capital is mostly used by smaller enterprises and holds higher leverage when they are placed in a high yield market. This in turn comes with a high risk. Fortunately, the high risk comes along with the benefit of a high return on investment as opposed to what secured lenders or senior lenders may provide.
Below are mentioned a few pros and cons that come along with financially indulging in mezzanine capital.
Advantages of Mezzanine Capital
1. Control over company’s direction and decisions
Losing some control over your enterprise could seem like a disadvantage. But mezzanine financing does not involve the owner losing all rights and still has control over the direction in which the company is proceeding.
All this would be in favor of the owner only if the company is progressing and growing without encountering any hurdles on the way from their lender.
2. Flexibility
The flexibility in the arrangement that comes along with utilizing a mezzanine capital is a big bonus for the company. Structuring coupons, as well as amortization, are possible all thanks to this feature of flexibility.
Moreover, this means that the cash flow requirements of the company can be accommodated easily.
3. Extra Capital
Mezzanine financing helps obtain some extra capital on the side. This capital can be utilized to start up a new business or expand the current business that they own.
This also means that they can venture into a new market area or start a new product altogether. This would heavily profit them in the long run. Companies such as revalprime.com provide such financing opportunities along with guidance in the most professional way possible and if you are looking for one such service, you must definitely try them out.
4. Strategy
The mezzanine lenders provide the companies assistance as well as give them some suitable strategies that they can follow to benefit themselves.
Professionals such as subordinated debt advisors help provide the companies with better direction as well as ideas as they know the field and come along with experiencing various scenarios in the field of finance. The experience that they hold helps them develop strategies that provide long-term value for the company.
5. Long Term Lenders
In most cases, lenders sign a contract with companies just to gain short-term benefits from it. The same does not apply in mezzanine financing as the lenders here have to stick around for the long term.
The investors stay long term and the benefits that they procure also arrive after some amount of time and not immediately.
Disadvantages of Mezzanine Capital
1. Back Breaking efforts
Arranging mezzanine capital is a taxing task and takes quite an amount of effort to perform. The process of doing so is very lengthy and time-consuming.
As a matter of fact, arranging for the majority of mezzanine deals takes a minimum of 3 months. Following this, the completion of the deal may take twice the amount of time taken to arrange the capital. This is the minimum time that it would take to acquire such a deal provided no obstacles or hindrances come in the way.
2. Expensive
Mezzanine capital does not come cheap. Senior debt or secured debt comes at a cheaper cost than this sort of capital.
The traditional method for obtaining capital also poses a cheaper alternative when compared to mezzanine capital.
3. Restrictions
Owners of companies on getting into a deal involving mezzanine finance would be subjected to certain terms and conditions that they must adhere to. These terms may include rules on how they are allowed to spend their money and on what they spend their money as well.
A great instance of this restriction can be looked into by taking the example of compensation of higher-level personnel. Market-price deals or packages cannot be offered to the prospect under consideration. At times, pay cuts and limited dividend payouts become the new normal for such employees.
4. Risk factor involved
The risk factor that comes along with indulging in mezzanine capital is high. The business owners or the entrepreneurs involved in such a setup are required to be daring and independent.
In cases where the business or the company isn’t able to meet the financial projections, the mezzanine capital investor has a say in the Board’s decisions.
5. Restrictive covenants
Restrictive covenants may be involved in Subordinated debt agreements. These constraints are placed on the loans provided by the investors or lenders as a form of safety as they do not have any control over the assets of the borrower.
Such covenants include not allowing the company to borrow more capital, cannot create more security interests in the capital as well as meeting certain financial ratios.
Summing It Up
Though mezzanine capital proves to be quite an expensive endeavor initially, its long-term benefits seem to outweigh the disadvantages that come along with it.
The advantages that come along with investing in a mezzanine capital such as flexibility in flexibility in arrangement, direction for the company, strategized assistance, long term investors and extra capital to be put to use for enhancing the company’s affairs seem to attract investors as well as companies to indulge in mezzanine financing.
On the contrary, the disadvantages that come along with investing in mezzanine capital include it being an expensive back-breaking endeavor. Furthermore, the restrictive covenants that come along with this capital, as well as the risks involved, are something that businesses have to consider before getting involved with mezzanine finance.
We hope the above pros and cons mentioned helped you out in simplifying if your company is ready to invest in mezzanine capital or not.
