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Mezzanine finance

Mezzanine financing is an “intermediate debt” plus additional return on investment known as the “equity kicker”
  • Mezzanine finance is a hybrid financial instrument combining features of both bank loan and private equity investment.
  • Mezzanine debt requires less collateral than a bank loan, since the transaction has an increased return on investment due to the equity stake taken by the investor.
  • Unlike private equity, mezzanine financing requires collateral for the loan portion of the deal, so the required rate of return is considerably lower when compared to the required rate of return of private equity investments.

Mezzanine financing can still be interest-bearing; while allows a firm to implement its strategy by securing the financial resources with an acceptable interest rate.

Mezzanine financing allows a firm to develop the strategic initiatives that it otherwise would not have been able to due to banks’ typical conservative approach in business risk assessment.

The term “mezzanine” in its financial meaning was borrowed from architecture.

Mezzanine (from Italian mezzanino, meaning “middle”) refers to intermediate floor in-between the main floors of a building.

Mezzanine occupies a niche between bank loan and private equity
Investment source
Optimal investment targets

Private equity

Start-up projects, companies with growth rates above the market average, and industry leaders. Company shareholders have to be ready to sell the business in 3-5 years to secure rates of return that are required by private equity funds.

Mezzanine

Business expansion, project finance, LBOs (leveraged buyouts) including MBOs (management buyouts). Such deals usually cannot fully rely on loans - due to the limited number of assets that can be used as collateral, or due to conservative assessment of cash flows by banks; however, relying heavily on private equity also makes little sense for the business owners.

Bank loan

The organic development of an existing project or business expansion that is comparable to the scale of the company. In such circumstances, existing cash flow of the business can secure the loan, even in the case of conservative risk assessment policy.

Comparison of the financial instruments
Bank loan*  Mezzanine financing  Private equity 
Interest rate 12 – 17 % 14 – 16 %
Target rate of return 12 – 17 % 20 – 25 % 30 – 50 %
Collateral Assets with a discount of 30 – 40% Equity
Less often liquid assets
None
Corporate governance Passive Passive Active
Basis for investment decision–making Ability to service debt Ability to service debt and growth prospects Obvious growth prospects
Exit strategy Repayment of loan Exercise of put/call option and repayment of loan

External investor, IPO

*Rates are stated for the project finance and investment loan products with more than 3 years of loan tenor.
 
Risk–return ratio

Risk–return ratio Hi Capital

Mezzanine financing is provided at the interest rates comparable with those offered by private banks.

Additional return is achieved by participation in equity and options (equity kicker).

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