Mezzanine funding for large scale business projects viola-funding October 3, 2023

Mezzanine funding for large scale business projects

Mezzanine funding
Mezzanine funding for capital intensive projects

Mezzanine funding is an intermediary between debt financing (such as obtaining a loan) and equity financing (issuing shares). Mezzanine funds originated in the United States and were then a revolutionary way to finance business. In Europe, such funds appeared in the 1990s, and their capitalization reached several hundred million euros in the first years of their existence.

It has traits for both debt and equity capital. In this case, the form of protection of the invested funds is the future cash flows of the investment project, but not the assets of the borrower. In fact, mezzanine is a hybrid form of financing, most suitable for the implementation of large capital-intensive projects.

Mezzanine instruments can be used to quickly raise capital in case of a fast growing business.

Based on the financial instruments used, mezzanine funding can be classified:

Debt mezzanine: loans received from project partners. (subordinated loans or secured) These can be different debt instruments in which the investor’s income is based on a fixed or variable interest rate.

Equity mezzanine: investor acquires a part of the business, including access to information about the company, the ability to control its activities and influence development. Thanks to warrants, an investor can obtain shares in order to profit from the increase in the value of the company.

Mezzanine funding has the features of the so-called subordinated debt.

based on the specific project, this form of financing may include various financial instruments. This can be, for example, bonds, loans or preferred shares.

Mezzanine funding can be provided by specialized mezzanine funds, venture capital funds or private equity funds (high risk financing).

On the other hand, lending banks accept an average level of risk, but require large collateral from customers.

When to use mezzanine funding

The providers of equity capital are the owners of the company (shareholders), while the providers of equity capital are usually banks, international financial institutions or other entities outside the circle of business owners.

Capital injection by owners is not always in line with their plans or capabilities. In addition, the latter solution may be subject to a number of stringent requirements and restrictions.

The main ways of financing investment projects, in addition to equity capital, are various types of investment loans provided by banks. Companies are often unable to obtain a long-term loan in the full requested amount on acceptable terms. This happens most often for two reasons. First, the company’s creditworthiness is insufficient. Second, the company simply does not have enough assets to use as collateral for a loan.

Raising funds through the stock exchange is time-consuming, expensive and does not guarantee a satisfactory valuation of the company. In addition, it can be difficult for the company and its owners to accept new obligations associated with the company’s listing on the stock exchange (for example, information obligations) or even the possibility of a business takeover by competitors.

Lack of the required financial resources at the right time can lead to an irreversible loss of unique business opportunities.

Mezzanine funding remains valuable way forward for companies in good financial stability.

The main task of this mechanism is to accelerate business development without additional risks. When choosing this method of financing a company, it is important to have experienced management and a well-defined company development strategy.

Mezzanine funding is feasible for:

• Financing the purchase of shares from a shareholder who decides to leave the company. Then the financial structure and ownership structure of the given enterprise changes.

• Long-term financing for the buyout of the company by a team of managers from the current owners.

• Expansion and growth of the company through mergers or acquisitions. The value of this company increases before the sale of its shares on the stock exchange.

Implementation of large investment projects in situations where commercial banks refuse to finance the cost of the project in full.

In the case of mezzanine funding, the ratio can reach 6, and sometimes even higher.

However, the value of this criterion depends on many factors, including the following: the company’s business reputation, its operating history, business plans and prospects, as well as the state of the industry and the current market situation.

Mezzanine capital is not suitable for newly established businesses.

These business entities are much more sensitive to all kinds of market risks. These companies have much smaller and, above all, less regular cash flows, so they cannot provide adequate collateral. They are viewed as risky partners for potential investors.

Mezzanine financing: procedures, tools, participants

The whole process of obtaining mezzanine financing consists of several stages.

At this point, it confirmed by due diligence carried out by external companies. The list of possible activities includes detailed legal, financial and tax due diligence and sometimes technical due diligence on complex projects.

The first stage is a preliminary analysis of an investment project, during which the main assumptions and the feasibility of such an investment are carefully checked. If it turns out that the project does make sense, the company begins to work more closely with the mezzanine fund. An initial analysis of the applicant company’s financial condition and its market environment is performed.

The most regular used mezzanine funding instruments include:

Loan with equity participation rights. This is an option for financing investment projects, in which the company incurs expenses in the form of interest.

A profit share loan gives the lender the right to a share of the profit from the implemented investment project. The profit share can, for example, be set as a percentage of the annual net profit for a predetermined period of time.

The essential parts of mezzanine funding is the ability to adapt conditions to the needs of a particular borrower.

It’s like a “tailor-made loan”. the documentations and conditions are devoid of  strictness.

Mezzanine funding: advantages and disadvantages for large businesses

The actual merits or advantages of mezzanine funding include the following:

• Payment of principal only at the end of the contract. This makes it easier for the funded company to maintain liquidity for the entire period of the investment project.

• Lower cost for company owners compared to issuing shares on the stock exchange or raising capital from a private equity fund.

• Possibility of obtaining financing, despite the lack of sufficient collateral and low creditworthiness, which effectively closes the path to obtaining bank loans.

Mezzanine funding has more advantages than disadvantages, two distinguished disadvantages should be noted:

• Necessity to conclude an agreement with many conditions that the financed company must meet. This could be, for example, provisions regarding the company’s refusal to take on further bank loans, or a provision allowing the mezzanine capital provider to block the company’s ability to make certain (risky) investments.

• Relatively high cost of capital compared to the cost of a bank loan.

Mezzanine finance bridges the gap between debt and equity financing. It also provide high degree of business flexibility when implementing large capital-intensive investment projects.

To find out more about international project financing, contact VIOLA FUNDING LIMITED.

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