Mezzanine capital is a specific form of financing that is particularly important for large-scale projects. Often, the investment sums required for commercial property are so substantial that such projects cannot be carried out efficiently without mezzanine capital. But what exactly is mezzanine capital, how can it be raised, and what are its advantages and disadvantages? This article provides a comprehensive overview of mezzanine capital and its potential applications.
Definition & Differences
In architecture, the term ‘mezzanine’ refers to an intermediate floor situated between the main storeys of a building. It is not counted as a full storey, but is included in the calculation of floor area. The concept of mezzanine capital works in a similar way: it represents an intermediate form between equity and debt capital.
The various types of mezzanine financing include:
- Subordinated loans: These loans rank behind senior loans in the repayment hierarchy. They are often used synonymously with mezzanine financing.
- Silent partnerships: Here, a company invests capital in a business and receives a share of the profits in return, but is not publicly mentioned and does not appear in the commercial register. Silent partnerships can be either typical or atypical, with atypical partnerships involving additional rights and risks.
- Convertible bonds and option bonds: Convertible bonds are corporate bonds that can be converted into shares at a predetermined price. Option bonds additionally offer the right to repayment and interest, as well as additional stock market options (warrants).
Advantages of mezzanine capital
Mezzanine capital can be advantageous for various reasons. Banks often only provide up to 70 per cent of the required financing, meaning that additional equity is needed. Mezzanine capital can be treated as equity, which leads to better financing terms. This is particularly advantageous for large-scale projects and can significantly increase returns.
Here is an example to illustrate this:
| Criterion | Without mezzanine financing | With mezzanine financing |
| Equity | 2 million euros | 2 million euros |
| Borrowed capital (BC) | 70% of 5 million euros (3.5 million) | 70% of 14 million euros (9.8 million) |
| Mezzanine financing | None | €4 million |
| Total project volume | 7 million euros | 14 million euros |
| Average profit margin | 12% | 12% |
| Profit margin (in euros) | 840,000 euros | 1,680,000 euros |
| Mezzanine capital costs | None | 10 per cent of 4 million euros (400,000 euros) |
| Profit margin after deduction of mezzanine costs | 840,000 euros | €1,280,000 |
| Increase in equity | 40% | 84% |
An example illustrates the leverage effect of mezzanine capital: with the same amount of equity investment, mezzanine financing can be used either to maximise profit or to diversify risk, even though this type of financing is more expensive than senior loans. Mezzanine investors often do not require collateral and do not exert any direct influence over corporate decisions. Provided the financing structure is transparent, banks generally have no objection to the involvement of mezzanine investors.
Costs of mezzaninefinancing
Whilst interest rates for senior financing are usually in the single-digit range, mezzanine financing is generally more expensive, with interest rates of between 8 and 18 per cent plus a profit share. These higher costs reflect the increased risk, as mezzanine investors are repaid after senior creditors in the event of insolvency.
To minimise costs, mezzanine capital should ideally be used towards the end of the project phase and for specific purposes, such as:
- Expanding existing business areas or opening new branches
- Management buy-outs (MBOs)
- Investments in technical innovations or digitalisation
Who is mezzanine financing suitable for?
Mezzanine financing is versatile and suitable for various target groups and situations:
- Medium-sized companies: These companies often use mezzanine capital for expansion, acquisitions or new product development. Although they have a solid cash flow, they sometimes lack the necessary collateral for traditional bank loans or do not wish to further dilute their equity.
- Private equity firms: These firms use mezzanine financing to structure takeovers or for recapitalisation. This enables them to increase their purchasing power and boost returns, whilst flexibly adjusting their capital structure.
- Property developers: They use mezzanine capital to finance construction projects, property acquisitions or renovations. This form of financing often complements existing sources of debt and equity and improves the return on investment.
- Start-ups and growing companies: For start-ups and growing firms with proven business models, mezzanine capital offers an alternative to traditional venture capital or bank loans, as it enables them to raise capital without having to give up significant equity.
- Companies undergoing restructuring: Firms in transitional phases, such as a change of ownership or strategic realignment, can benefit from mezzanine financing to facilitate the transition and capitalise on growth opportunities.
- Management teams in buyouts: Management teams frequently use mezzanine financing for management buy-outs (MBOs) or buy-ins (MBIs). This financing enables them to acquire shares in the company and complete ownership transfers whilst retaining operational control.
Conclusion
Mezzanine capital plays a significant role in the financing of large-scale projects and represents a valuable complement to traditional forms of financing. It combines elements of equity and debt and, under certain circumstances, offers attractive terms and a high degree of flexibility. Despite higher interest rates and profit-sharing arrangements, mezzanine financing offers many companies and investors an effective way to raise capital and successfully implement projects.
If you need assistance in securing mezzanine financing and are looking for a bespoke loan structure for your project, you can contact the experts at OFFMARKET24. We will be happy to help you with a precise calculation and find the optimal solution for your needs.
