Mezzanine financing derives its name from building mezzanines which are a level above ground floors. As such, mezzanine financing is a junior debt form that sits above common equity but below senior debt and is frequently associated with buyouts and acquisitions.
But what is mezzanine financing and how does it work? This blog post explores that and more.
This is basically a business loan with repayment terms that are adapted to organizational cash flows. In other words, it is a hybrid of equity and debt financing that permits the lender, in the case of default, to convert the obligation to an equity interest in the organization. This usually occurs following payment to venture capital companies and other senior lenders.
This type of blended financing can help with large projects, growing businesses, and management projects.
A somewhat complex form of business loan, it involves interest payments and equity features and assumes a middle position — “mezzanine” comes from “middle” in Latin — between senior debt and equity.
Companies seeking to raise money generally can either take on debt through a business loan or use equity, which calls for selling a business share in exchange for cash. Mezzanine finance can also be a way to finance property development.
Generally, this type of finance is employed in cases in which the perceived risk is so high that a traditional business loan will not secure sufficient money. Equity finance would ordinarily be an option, but a lot of companies do not wish to relinquish business shares.
Ultimately, mezzanine financing permits a larger investment, with the goal of a bigger return. While it is high risk, returns for investors in debt often reach between 12% and 20% annually. In terms of repayment, some situations call for a lump sum, while other situations necessitate a deferment of interest payments. The interest in mezzanine finance may also be tax deductible.
In essence, “mezz finance,” as it is often called, can be considered a business loan in which the debt is turned into an equity share following the passage of a pre-established time period. Thus, if the company cannot repay the funding, the lender instead gets an equity share. Here, equity in the business is employed as security.
Then there are other contexts in which such finance marries equity and debt by offering a share of profit in addition to interest payments. So, the business borrows money, and the lender procures a share of the benefits in return.
In the end, mezzanine financing may be viewed as either a very pricey debt or less-expensive equity. While such financing has a higher interest rate than the senior debt companies would normally be able to get through their financial institutions, it is markedly cheaper than equity relative to overall capital costs.
There are various types of mezzanine financing, including:
Figuring prominently in most mezzanine financing are:
Despite risks and considerations that will be listed below, there are distinct advantages to mezzanine financing. Such benefits include:
As with most aspects of financing, there are risks and other considerations involved in mezzanine financing. The chief ones include:
Mezzanine financing is popular in real estate and is often used to help fund the purchase of a new development or an acquisition project. Such loans provide capital in the form of subordinated debt to investors and borrowers.
In fact, real estate itself remains a popular investment, in part because it is what is called an “alternative” – an asset other than the stocks, bonds, or cash that comprise traditional portfolios. Because of their low correlation to public markets, such assets decrease portfolio volatility. When added to an investment portfolio, they can also potentially generate secondary returns and help protect against inflation.
The leading alternative investment platform Yieldstreet, on which nearly $4 billion has been invested so far, offers the broadest selection of alternative assets classes available. Such curated and highly vetted private-market offerings include structured notes, art, transportation, legal finance, private credit – and real estate.
Yieldstreet’s real estate opportunities include private and commercial offerings and a Growth & Income REIT, which makes debt and equity investments across varying investment and property types in key areas around the nation. Such investments can help enable the fund to produce investor returns.
An additional key benefit of investing in alternatives is portfolio diversification, which is essential to successful investing. Crafting a portfolio with a mix of varying asset types can not only stabilize results but can improve prospective returns. Importantly, it can also mitigate portfolio risk.
Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.
However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments.
Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $5000.
Compared to typical corporate debt, mezzanine financing can provide investors in debt with generous returns, frequently paying between 12% and 20% annually, and even more. However, because it is unsecured, such financing can carry higher risks. Remember that there are a number of ways to include real estate in holdings and diversify portfolios.
Yieldstreet provides access to alternative investments previously reserved only for institutions and the ultra-wealthy. Our mission is to help millions of people generate $3 billion of income outside the traditional public markets by 2025. We are committed to making financial products more inclusive by creating a modern investment portfolio.