Mezzanine financing is used by property developers to bridge the gap between a development facility or loan and the amount of equity that a developer has available to invest. With a mezzanine fund, developers are able to provide less of their own cash investments to secure project funds.
If a developer doesn’t have sufficient resources to complete a project with a senior debt facility alone, mezzanine finance can be used as a second charge to ‘top-up’ funds from the first. The lender will need to take a second charge on the land and the development, giving them a ‘junior’ position, behind the first charge of the senior debt finance lender.
Mezzanine lenders usually back a development on the understanding and agreement that they will receive full repayment of their initial investment, plus an interest amount which reflects their perceived risk.
Broadly speaking, there are three categories of business funding: debt, equity and mezzanine finance.
From business loans to commercial mortgages, debt finance is the blanket term that covers most borrowing. The details of debt finance can vary based on the lender’s criteria or the situation of the borrower, but essentially, a business is taking on debt from a lender. Businesses receive funding from a lender in exchange for regular repayments that add up to the borrowed amount plus interest.
Rather than repaying a lender for borrowed cash, equity fundraising gives developers the option to sell shares of their business to investors – giving their new stakeholders the chance to benefit from future growth of the business. Equity fundraising is a riskier proposition for Investors, as they’ll share any losses that the business suffers. This avenue is usually part of a larger, long-term strategy for venture capitalists and private investors.
Mezzanine financing is often viewed as a middle ground between debt and equity; combining the risk and reward of equity fundraising with the security and predictability of debt repayments.
A common arrangement of mezzanine funding is that it will essentially act as debt finance that will convert to equity financing. Essentially, a developer will make repayments as normal if things go according to plan, whereas lenders will convert owed repayments to company shares if a business can’t make the repayments.
Another option for developers choosing to use mezzanine financing is to offer shares of the business as a form of collateral for the loan.
Like any form of financing, mezzanine finance has its pros and cons. It’s important to make sure you thoroughly research what is entailed when applying for mezzanine finance so you can judge whether the advantages outweigh the potential risks.
Typically, mezzanine funding providers will restrict their lending to more experienced property developers who can boast a history of successful projects. Mezzanine finance can be a risky investment for lenders, which is why they have such strict lending criteria to ensure they feel confident in the ability of a developer.
Lending criteria for mezzanine financing include the following:
In most cases, the rates for mezzanine financing start from 1% per month with a 2% facility fee and a 1% exit fee. Like any financing solution, rates for mezzanine funding will vary between lenders and will be based on a project basis, so it’s important you find the right lender for you and your business.
Examples of factors that will affect the rate of your finance include:
In order for your mezzanine financing application to progress and be approved, there are a number of details that you must provide to the mezzanine lender:
As the UK’s leading development finance and bridging loan specialists, our experts at Positive Commercial Finance can help you find the best financing solution for you and your business.
If you have any questions or would like to learn more about bridging loans, don’t hesitate to get in touch.