What is Mezzanine Finance?
If you're looking to raise funds for a project and would like to minimise your capital requirement or if you are nearing completion and would like to release equity to start your next project or purchase, it may be worth considering a mezzanine finance structure. Mezzanine finance is a type of funding that sits between senior debt and equity and these facilities can be useful for developers looking to maximise their return on capital. In the points below, we'll provide deeper insight to what mezzanine finance is, how it works, and what you need to know before considering this form of funding.
What is mezzanine finance?
Mezzanine finance is a form of funding that ranks behind senior debt but before equity. Typically a mezzanine loan will be secured by a second mortgage over the title which will enable the mezzanine funder to be paid out at the end of the project after the senior debt is paid off. There will usually be an agreement between the senior debt provider and the mezzanine finance provider, called a priority deed, confirming the priority of debt repayments at the end of the project.
What are the benefits of mezzanine finance?
The primary advantage of mezzanine finance is that the developer can reduce their capital in the project without giving equity away. While the interest rates and fees associated with mezzanine loans are considerably higher than senior loans, for a profitable project it will be a lot cheaper than raising equity which usually comes with profit sharing arrangements or a higher coupon interest rate. By using mezzanine finance, the developer may be able to increase their return on capital for the project and may also help them spread their capital across multiple projects at once.
Another potential advantage with using mezzanine finance is that for projects that have achieved strong pre-sales it may be a way of using a bank for the senior debt while still financing at a high leverage. In some circumstances the combination of cheaper senior debt financing and a mezzanine loan will result in an overall lower cost of funds than funding the entire facility through private funds.
Of course, there are also risks associated with using mezzanine finance to fund your project, with higher gearing, higher interest rates and more than one loan to keep in order. It is important to get the right advice and understand all of the potential risks and benefits before moving ahead with a mezzanine finance facility.
Some things to keep in mind when considering mezzanine finance
First of all, you need to ensure that you are getting the right advice to make sure that the structure works for you and that you understand the risks and benefits of using mezzanine finance before deciding to proceed.
Secondly, you need to be dealing with reputable funders. There are always many things to do with a project that are out of your control but the cost for delays or issues associated with a project almost always fall on the developer. Dealing with funders that will work through these situations and a commercial and reasonable manner is critical and could be the difference between success and disaster.
Lastly, the legal side of mezzanine finance can get a little messy, particularly when there are multiple lenders involved. It is important that you have good legal representation and fully understand the legal requirements for both senior debt and mezzanine debt.
Having a trusted partner to guide you through these potential pitfalls and benefits will help ensure that your project is successful.
At MFEG, we pride ourselves on providing tailored funding opportunities and solutions for qualifying borrowers. Whether you are exploring mezzanine finance options, preferred equity finance, residual stock finance or otherwise; get in touch for a consultation.