Businesses that do well expand over time and this invariably requires additional capital. Additional funds may be needed to complete a project or to purchase and develop a property. In any of these scenarios, mezzanine finance is an option if you can't secure all the funding from a bank.
If you are approved for a bank loan but the amount doesn't cover your total costs, or if additional costs to finish your project crop up, you can consider mezzanine finance. While the money you borrow through mezzanine financing will generally attract higher interest than conventional loans, you will get access to that much-required capital.
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Updated February 22nd, 2020
How does mezzanine finance work?
Mezzanine finance is typically used to fund property projects or complete expansions. If additional costs are incurred during a project and your bank loan won't cover it, you can take out a mezzanine finance loan and secure it to your property. Unsecured loan options are also available. The loan you're approved for is typically based on the property's assets and the equity that is projected from the completion of the project.
If you're looking for mezzanine financing, take into account that lenders will look at factors such as profitability, your business track record, and viable plans for expansion. If you are not able to pay the borrowed money back in time, the lender can claim equity interest in your company or even a right to ownership.
How to compare mezzanine finance offers
While mainstream lenders normally shy away from providing mezzanine finance, you still have numerous options to choose from. Keep the following guidelines in mind:
- Secured or unsecured?. While mezzanine finance is typically secured, some lenders require little or no security whatsoever. However, unsecured deals usually feature a fairly high interest rate. Lenders can also provide finance based on existing assets along with projected equity, where you're essentially using a second mortgage to secure the finance.
- Interest rate. No matter which lender you choose, pay careful attention to the interest rate you'll be paying. Both fixed and variable rates are available with these business loans; select the one that works best for you. Fixed rates provide more planning certainty, but variable rates may be beneficial if the general trend for rates is downwards.
- Fees and charges.. Common fees and charges include application fees, disbursement fees, account-keeping fees and late charges. These vary widely between lenders, so be sure to factor them in when comparing options.
- Repayment flexibility. Check if the lender charges penalties for early repayments.
Pros and cons of mezzanine finance
Pros
- Secure additional financing. If you cannot get as much money as you require through a business or commercial loan, mezzanine finance offers you an alternative option to complete your project without straining your cash flow.
- Quick access to funds. Providers of mezzanine finance don't apply as much due diligence as conventional lenders, so you can expect to hear about your application's status soon after applying. Getting access to your approved funds should not take long either, meaning fewer delays in your project.
- Equity on your balance sheet. When your business secures mezzanine finance you get to treat it as equity on the balance sheet, which can make getting other loans from conventional banks simpler.
- Hold on to properties for longer. With mezzanine finance in place, you have the ability to hold on to your properties for longer while waiting for equity to build.
Cons
- High interest rate. Since mezzanine finance providers view their investments as high risk, they charge higher interest compared to conventional business or commercial loans. You can expect to pay even higher interest if you can't provide some form of security.
What you should avoid
Before you apply, make sure you have a thorough plan of action in place to repay the money. If you don't keep up payments, you can potentially lose your business. Avoid paying unnecessarily high interest by comparing a wide range of mezzanine finance lenders. If you notice higher fees and charges, see if other lenders are able to offer you more competitive terms. Don't agree to the loan without going through the associated terms and conditions carefully.
Have more questions about mezzanine finance?
Who can get mezzanine finance?
As lenders tend to look at keeping risk to a minimum, make sure you have as much information about your business and your project as possible. If you can provide around 40% to 50% of your project's total costs, you might qualify for mezzanine finance.
Can I repay the borrowed money ahead of time?
In most cases you can pay the borrowed money off before schedule, but find out if doing so attracts any penalties.
How much money can I borrow?
The answer to this depends on the lender you approach, as most have varied minimum and maximum lending limits.
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