Mezzanine Financing
When Using Subordinated Financing Pays Off
Mezzanine capital and mezzanine financing are particularly popular in large-scale project financing. Often, the substantial purchase prices required for acquiring commercial properties would not be profitable—or even feasible—without mezzanine capital. But what exactly is mezzanine capital? How can it be obtained? And what are its advantages and disadvantages? This article explores these questions. If you’d prefer to listen to this topic in audio form, you can do so here:
- Definition & Types
- Advantages
- Costs
- Target Groups
- Summary
Definition & Types
In architecture, the term mezzanine refers to an intermediate or half floor within a multi-story building. A mezzanine level does not count as a full floor but is still included in the calculation of total floor space. The same principle applies to mezzanine capital: it can be classified as both equity and debt.
There are several forms of mezzanine financing, including silent partnerships, subordinated loans, convertible bonds, and option bonds.
Subordinated Loans
Subordinated loans are are named for their lower ranking compared to traditional (senior) loans. This means that in the event of repayment, the subordinated lender only receives payment after the senior loan has been repaid. The term subordinated financing is often used interchangeably with mezzanine financing.
Silent Partnerships
A silent partnership occurs when an investor contributes capital to a company and shares in its profits, but does not appear publicly as a partner—nor in the commercial register. There are two main types: typical and atypical silent partnerships. In an atypical silent partnership, the investor has more rights but also takes on more risks, as they participate in both losses and hidden reserves.
Convertible Bonds and Bonds With Warrants
Corporate bonds that can be converted into shares at a predetermined conversion price are called convertible bonds.
Advantages
There are several reasons why it can be worthwhile to raise mezzanine capital. As banks are now often less willing to provide more than 70 percent of the financing, the equity capital must be increased. No matter which form of mezzanine financing you choose: Due to the fact that mezzanine capital is attributed to equity, the conditions with mezzanine can be significantly better than without. This gives you more leeway, especially when it comes to implementing large-scale projects. It also gives you the opportunity to significantly increase your own income.
This is best explained with an exemplary calculation based on the following factors:
Equity (E): €3 million
Mezzanine financing: €6 million (double the equity amount)
Mezzanine interest rate: 12.5% (e.g., via Exporo)
Average profit margin (based on total investment): 15%
A mezzanine financier wants to contribute twice the amount of the investor's existing equity, which is €3M.
Without mezzanine | With mezzanine |
|---|---|
€3M E + 70% loan (€7M) | €3M E + €6M MF + 70% loan |
= €10M project volume | = €21M project volume |
€1.5M profit margin | €4.5M profit margin - Mezzanine cost |
= 50% capital increase | = 100% capital increase |
As this example shows, mezzanine capital can create a strong leverage effect. In other words, with the same equity contribution, mezzanine financing allows investors to maximize profits or diversify risk even though mezzanine financing is more expensive than senior debt.
Moreover, mezzanine lenders typically do not require collateral and have no direct influence on company decisions. As long as the project structure and financing breakdown are transparent and well-documented, banks are generally receptive to the inclusion of mezzanine capital providers.
Costs of Mezzanine Financing
While interest rates for senior loans are typically in the single digits, mezzanine financing rates are usually in the double digits—commonly between 10% and 20%, plus a profit participation component. This makes mezzanine capital relatively expensive, which should always be factored into calculations. The higher cost reflects the increased risk faced by mezzanine investors, who are repaid only after senior creditors in the event of insolvency.
To manage costs effectively, mezzanine capital should generally be used toward the end of a project phase or for a specific strategic purpose, such as:
Expansion plans (e.g., new branch openings or capacity increases)
Management buyouts (MBOs)
Technological innovations or digital transformation initiatives
Who is Mezzanine Financing Suitable For?
Mezzanine financing can be a suitable solution for investors in various situations:
Medium-Sized Enterprises
Mezzanine financing is ideal for mid-sized companies pursuing growth initiatives such as expansions, acquisitions, or product development. These businesses often have established operations and cash flow but may lack the collateral or credit profile required for traditional bank loans—or may prefer not to dilute ownership by issuing new equity.
Private Equity Firms
Private equity firms often use mezzanine financing to structure leveraged buyouts (LBOs) or recapitalizations. This allows them to increase purchasing power, enhance investment returns, and maintain flexibility in tailoring the capital structure to the specific transaction.
Real Estate Developers
Real estate developers commonly use mezzanine financing for construction, acquisition, or renovation projects. It serves as a bridge between senior debt and equity, allowing developers to optimize capital efficiency and maximize returns without giving up substantial ownership stakes.
Startups and Growth-Stage Companies
Although less common, startups and growth-stage firms with proven business models and steady revenue streams can also benefit from mezzanine financing. It offers an alternative to venture capital or traditional bank loans—providing access to capital without surrendering significant equity or pledging hard assets as collateral.
Companies in Transition or Restructuring
Businesses undergoing transitions—such as ownership changes, restructuring, or strategic repositioning—can use mezzanine financing to bridge gaps and seize growth opportunities. The flexible repayment structures of mezzanine loans can accommodate variable cash flows and uncertain operating environments.
Management Teams in Buyouts
Management teams engaged in buyouts (MBOs or MBIs) often turn to mezzanine financing. By combining mezzanine loans with equity contributions, managers can acquire ownership stakes or facilitate ownership transitions while maintaining operational control and aligning incentives with financial sponsors.
Summary
Mezzanine capital and financing play a crucial role in large-scale project financing, especially in commercial real estate acquisitions where high purchase sums are involved. Mezzanine capital blends elements of equity and debt, offering flexibility and attractive terms compared to traditional financing options. Subordinated loans, silent partnerships, and convertible bonds are common forms of mezzanine financing, each with its advantages and costs. While mezzanine financing can increase leverage and support diverse projects like expansions, management buyouts, or innovations, it comes with higher interest rates and profit participation. However, its flexibility and ability to enhance returns make it appealing to middle-market companies, private equity firms, real estate developers, startups, companies in transition, and management teams seeking strategic capital solutions.
Urbyo Professional can help you secure mezzanine financing and help you find the right loan structure for your project. Create a profile by signing up for an account or simply contact us for more information and we will get you started.
Mezzanine capital and mezzanine financing play a crucial role in large-scale project funding—particularly in commercial property acquisitions involving substantial sums. Combining features of both equity and debt, mezzanine capital offers flexibility and attractive terms compared to traditional financing.
Common forms include subordinated loans, silent partnerships, and convertible bonds, each with distinct advantages and costs. While mezzanine financing can enhance leverage and support projects like expansions, management buyouts, or innovation initiatives, it also carries higher interest rates and profit-sharing obligations.
Nevertheless, thanks to its flexibility and potential for higher returns, mezzanine financing remains an appealing option for mid-sized businesses, private equity firms, property developers, startups, transitioning companies, and management teams seeking strategic capital solutions.
Urbyo Professional can help secure mezzanine financing and design the optimal loan structure for your project. We can calculate precisely what is most profitable for you. Create a profile by signing up for an account—or contact us directly for more information, and we’ll get to work for you.
