A blend of debt and equity financing used to finance a company’s expansion, which gives the lender the right to convert the debt obligation to an equity or ownership interest in the company if the loan is not paid back in full by its maturity date. As a result, it functions a debt-equity financing hybrid.
Financial hybrids usually evolve as the result of a particular need within the industry that isn’t quite satisfied by one existing option or another. Mezzanine financing primarily evolved as a tool to be used during acquisitions and buyouts involving bankruptcy in order to give financial benefits to the new owners of the company as opposed to directing financing to existing debtholders. As a result, this kind of financing is treated as equity in regards to a corporation’s balance sheet.
Mezzanine financing does not generally require collateral on the part of the receiver, as a default will result in a windfall for the lender in the form of equity. This flexible financing hybrid is nevertheless a very high-risk form of debt and must be treated cautiously by borrowers. High rates of return are all well and good, but defaulting on this kind of financing is no small consequence. With that said, lenders usually extend mezzanine financing to companies that tend to be very stable and benefit from both an excellent reputation and a grounded vision of expansion. As a result, this financing option is not quite so outlandish when extended to profitable companies likely to be able to pay their debts back by an established deadline.
Executive: “So, because we are acquiring that boutique clothing company on the verge of bankruptcy, we have been offered a mezzanine financing package by our usual lender?”
Accountant: “That is correct. We just need to think carefully about the risks of accepting that offer.”
Executive: “Hmmm. Okay.”
Accountant: “Has anyone ever told you that you look like Winnie-the-Pooh when you’re concentrating on something?”