What Does Mezzanine Financing Mean?
A hybrid of debt and equity financing that is is typically used to finance the expansion of existing companies. Mezzanine financing is basically debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies.
Since mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.
Debt that incorporates equity-based options, such as warrants, with a lower-priority debt. Mezzanine debt is actually closer to equity than debt, in that the debt is usually only of importance in the event of bankruptcy. Mezzanine debt is often used to finance acquisitions and buyouts, where it can be used to prioritize new owners ahead of existing owners in the event that a bankruptcy occurs.
Mezzanine capital, in finance, refers to a subordinated debt or preferred equity instrument that represents a claim on a company’s assets which is senior only to that of the common shares. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.
Mezzanine capital is often a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the result of its location as an unsecured, subordinated (or junior) obligation in a company’s capital structure (i.e., in the event of default, the mezzanine financing is less likely to be repaid in full after all senior obligations have been satisfied). Additionally, mezzanine financings, which are usually private placements, are often used by smaller companies and may involve greater overall leverage levels than issuers in the high-yield market; as such, they involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or other more senior lenders.
For a variety of reasons, developers of large projects may not be able to obtain their desired level of financing for a development.
Typically, institutional lenders will not go above 60-70% loan to value ratio for real estate developments. Mezzanine lenders will assist the developer in raising the loan to value ratio to between 70% and 90% and higher by (i) the mezzanine lender will provide financing in a “junior debt” position and receive a fixed income yield in a typical 8% to 12% range under a debt instrument like a mortgage or debenture; or (ii) relying on participating debt or preferred equity which combines a fixed income component and a participation or exit fee.
Security in the project varies depending on the nature of the deal between the mezzanine lender and the developer but there are some common elements.
Debt Mezzanine Financing
Such financing may involve any of the following:
Second Mortgage or Debenture. This allows a lender the most secure form of collateral and permits a mezzanine lender to foreclose on the project in a default. This security requires the consent of the senior lender and an interlender agreement or subordination agreement to set out the relationship between the mezzanine lender and the senior lender.
Assignment of Interest of Developer. This allows the mezzanine lender to take the developer’s interest in the project in the event of a default. Essentially, the mezzanine lender is becoming an equity owner and will assume the obligations owed to the senior lender on a takeover of the project.
Cash Flow Note/Soft Second Mortgage. This provides that the mezzanine lender receives an assignment of cash flow from the project in exchange for mezzanine loan proceeds and a percentage of the proceeds from a sale of the project or lease income. No security is registered and, therefore, an inter creditor agreement with the senior lender is not necessary.
Equity/joint ventures involve the following:
Partnership Agreement/Joint Venture Agreement. The advantage to the mezzanine lender is that it obtains control over many major decisions especially surrounding cost increases or cost over-runs. The advantage for the developer is that it will be required to contribute much less cash to the project (sometimes as little as 5%). An additional advantage for the developer is that it has the benefit of a partner who may be able to help if the project falters.
Security Agreement. Generally, the equity mezzanine lender will secure its loan with security in most cases over the lands involved in the project. In some cases, the mezzanine lender will take alternative security such as a pledge of shares, warrants for the issue of shares or personal property security.
The intercreditor agreement is the essential link between the senior lender and the mezzanine lender’s rights in a default situation. The intercreditor agreement sets out the system of communication between the senior lender, the developer and the mezzanine lender. An intercreditor agreement typically deals with the following issues:
Priority of Security Between Senior and Mezzanine Lenders. Often the mezzanine lender will want to tie the senior lender to a fixed debt and interest amount and prefer that the senior lender not be able to re-advance any principal amounts or make changes to the financial structure of the senior loan.
Notification of Defaults under the Senior Lender’s Security. This notification may include a “standstill” period during which the mezzanine lender either cannot enforce its security or may also be prohibited from collecting any amounts from the developer. For this reason, the mezzanine lender will often maintain an interest reserve to allow for continuing payments of interest even during a standstill. The standstill period usually commences on a notice of default and ends when the senior lender is brought current or commences foreclosure.
A Right to Cure Defaults under the Senior Lender’s Security. This allows the mezzanine lender to take over the project and complete the development to realize its profits.
The Right to Enforce its Own Security. This right usually occurs either after a specified period of time or once the senior lender has started enforcement. The definition of enforcement is critical since a senior lender will want the mezzanine lender to refrain from enforcement as long as possible, while a mezzanine lender will want enforcement to be confirmed to be “real” enforcement such as foreclosure or appointment of a receiver over the project.
Repayment of the mezzanine loan may occur in several ways. One of the most typical scenarios is the orderly repayment of the mezzanine by the developer, either through the planned sale of the project or by the funds available through the developer’s “take-out” or permanent financing to replace the senior lender and the mezzanine lender. Another exit is where the cash flow of the project is sufficient to service the debt on the senior lender but not sufficient to the pay portion of the mezzanine. In such a scenario, the developer and mezzanine lender will negotiate an outcome but often the mezzanine lender can take an interest in the project.
Profit participation loans can be structured in such a way as to avoid problems with the priorities between creditors in a bankruptcy. Section 139 of the Bankruptcy and Insolvency Act (Canada) may preclude an equity investor from claiming priority over the general class of creditors of the bankrupt. A claim that can be construed as a loan will not be postponed to other creditors in a bankruptcy situation in the same way. It is critical that any equity or profit participation type of arrangement be structured as a loan so that the mezzanine lender can argue for its priority over other creditors. Security that is taken in connection with the loan will be enforceable. Accordingly, it is recommended that every mezzanine loan require some limited security to enforce in the case of a bankruptcy. Talk dirty to try click academic site to stimulate someone sexually by speaking provocatively 24