Businesses usually require a lot of capital when in the phase of expansion. It may be that the firm needs additional funds to purchase a certain property so as to develop or to complete a certain project. In some cases the funding you get from the bank can be inadequate, so you will need the mezzanine finance as the option to finance such scenarios.
Mezzanine finance is very helpful to cover immediate additional costs that have just cropped up or to where the bank loan amount will not cover the total costs of the project. The good thing with mezzanine finance is that you will get the capital you need even if the interest rates are higher than the normal conventional loans.
Operation of mezzanine finance
Mezzanine finance as earlier noted is useful in completing expansions or funding property projects. You can also secure a property through mezzanine finance loan if the amount that you got is not enough to secure the purchased or leased property or when some costs in the development of the property have cropped up. The equity and the property’s asset form the basis for approval of the loan that is needed for completion of a particular project.
For lenders to give to allocate mezzanine financing for their borrowers, they will check attributes like expansion plans, business track record, and profitability. However, the lender can claim equity interest or ownership rights from the company if the borrowed money is not paid in time.
Example of mezzanine finance
To simplify how mezzanine financed works, take an example of a property developer that intends to put a structure in a land property. Such kind of property investor has three probable sources of finance that can enable the project to be completed as scheduled.
Initially, the developer will approach a bank to acquire a land mortgage loan to start off. But, the bank might decide to lend only a limited amount, maybe 50%. Later on, the developer can approach the mezzanine investor to lend the second mortgage. The mezzanine investor could decide to give the next 45% of the funds.
However, in case of default, the property developer will need to pay the first mortgage first then what is left will settle the next mortgage. The developer will have to finance the remaining 5% of the funds out of own contributions.
Things to examine in mezzanine finance offers
When securing any mezzanine finance, certain factors ought to be considered:
Interest rate: this component is very crucial for any borrower to pay attention to regardless of the lender that gives the finance. The main rates for most loans are normally variable and fixed rates, but you as the borrower will have to select the one appropriate for the business. In cases where there is uncertainty, fixed interest rates are the most suitable, otherwise, where the trend seems to be declining, variable rates will be the most suitable rates to apply.
Unsecured/ secured: most of the mezzanine finance available in the financial market is normally secured. However, other lenders can give this type of financing with little or no security. The interest rates are usually higher when the financing is unsecured. When the second mortgage is utilized to get the financing, lenders can permit allow the projected equity and the existing assets to be used to gain the requisite financing.
Charges and fees: the finance comes with some charges and common fees like account-keeping fees, disbursement fees, application fees, late charges and application fees. When checking these charges for the financing, keep in mind that the expenses could vary depending on the lenders.
The flexibility of repayment: examine whether penalties are levied because of early repayments.
Advantages and disadvantages of mezzanine finance
Gives additional finance: mezzanine finance is the best alternative option where adequate money cannot be sourced through a commercial or business loan to undertake a given project without putting pressure on the company’s working capital.
Crucial Equity: Mezzanine finance that is accessed can be utilized as equity item on the balance sheet to ease the acquisition of conventional bank loans.
Funds quickly accessed: you will only delay your project at minimal times since approval of the funds usually does not take that long. So after applying for finance, expect to hear about the status soon since the due diligence applied is less than for conventional funds.
Enables longer property holding: as investor mezzanine financing gives you the ability to hold longer property as you wait for finance to construct on the property.
Interest rates are High: you should expect to pay a higher interest rate for mezzanine finance as compared to other commercial or conventional loans. In cases where there is no security, the mezzanine finance providers will charge an even higher interest rate for the loan due to the higher risk of investment.
Getting a mezzanine finance
When trying to secure any mezzanine financing, ensure you possess adequate information for the intended project or business. To stand a high chance of qualifying for mezzanine financing, you ought to prove that you are in a position to finance around 40-50% of the total cost of a particular project. Make sure that you do not pay the borrowed money before the scheduled period otherwise you are bound to suffer numerous penalties.
What to avoid
You should be cautious when applying for the finance as you land the risk of losing your business if you don’t make the payments in time. As such, you ought to have a thorough plan of action of how you intend to repay the money borrowed before you even apply. Make sure you compare the interest rates that various mezzanine finance lenders charge so as to avoid paying unnecessarily high-interest rates. Ensure that you also check on the terms that lenders offer to choose the competitive ones that are devoid of higher charges and fees. It is not advisable to enter into a loan agreement blindfolded without carefully perusing on the terms and conditions.