Mezzanine Financing Analysis
Companies use mezzanine financing to raise money without having to issue additional equity capital. This type of financing is a mixture of both debt and equity capital. A company obtains this loan as an unsecured debt from investors without giving them any ownership stake.
The rate of interest at which mezzanine debt is obtained is exceptionally high.
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Issuance of Mezzanine Finance
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Usually, companies adopt this route of financing whenever they are on an expansion spree. They obtain this money from investors at very high rates of interest. There is no collateral attached to this loan. The investors are given the option to convert owed funds into equity shares, debentures or share warrants of the company at any point in time.
The company's balance sheet shows mezzanine finance under the classification of equity capital. Even then, it is always treated as loan.
Raised After Traditional Loans
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Mezzanine finance is issued by companies that have exhausted all means of obtaining loans from the market. Banks and financial institutions set limits on how much a company can borrow. These limits are deemed to be safe limits and the probability of the company defaulting on repayment is low.
The company first procures as much money as it can from the market. In case it still requires money, it resorts to mezzanine financing. Investors may seek a return as high as 30 percent.
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Acquisitions
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Companies use mezzanine financing when they are looking at acquiring another sluggish company. The parent company puts in a little of its own money and raises the remainder through mezzanine financing. Once the company has been acquired, the parent company makes modifications to the acquired company. It mends its policies, procedures and systems, aligning it with its own.
When the parent company feels that the acquired company has stabilized, it may issue public shares of stock. Investors are willing to buy shares based on the financial credibility of the parent company.
Ownership Is Not Diluted
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With mezzanine financing, companies are able to raise money without going public. Also, mezzanine financing does not dilute the ownership stake of the existing equity holders of the company. These new investors have no say in the conduct of the business. Nor do they have voting rights in the company.
The company's debt-equity ratio is also optimally placed. Mezzanine debt appears under the heading of equity capital, therefore there is no additional debt burden on the company.
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