Businesses are often faced with the question – how can we fund our growth or next project? Here, Yavan Brar, managing partner and head of corporate at Herrington Carmichael LLP, explains the concept of a hybrid between the two main methods of equity and debt – mezzanine finance.
Mezzanine finance is a sum lent or invested into a business on a junior basis that ranks in priority behind senior debt, but ahead of standard equity.
For property developers, mezzanine finance represents a viable means of making up a shortfall in funding provided by a senior lender. It also allows developers to protect their cash flow by taking long term debt rather than using their own cash.
It is commonplace for the breakdown of funding to be split 70:20:10 between the prime lender, the mezzanine lender and the developer, but in some situations, mezzanine lenders are willing to loan up a higher percentage of the total development costs for a particular development project.
The benefit of mezzanine finance is that it reduces the amount of personal capital or personal equity that is required to be invested into a single project. The lower level of personal funds that are required to be invested as a developer enhances the return on capital employed and allows the property developer to take on a greater number of development projects at the same time, which can open up further revenue streams for the property developer. In the UK, mezzanine finance can be made available through several different structures based on the specific objectives of the transaction. Mezzanine lenders will typically look for a certain rate of return which can come from cash or ‘payment in kind’ (PIK) interest, but could also come from an equity stake in the borrower.
Dedicated property mezzanine lenders would typically expect to see the mezzanine finance used for capital expansion and growth in the property development business. For example, the mezzanine finance may be used to finance the development of a new site, potentially where there is a shortfall in the advance provided by the senior lender. Mezzanine finance is appealing to property developers for a number of reasons, when compared with standard debt and equity financing. Namely, these benefits include:-
Mezzanine lenders do not typically seek to get involved with the management of the property development company.
The property developer may have the benefit of flexible repayment mechanisms to the mezzanine lender.
It comes at a lower cost in comparison with raising equity or selling shares to an investor.
The property developer will get access to funds which may be over and above what senior lenders are willing to fund.
In addition, in our experience, mezzanine lenders are generally very quick to act on borrowers’ requests, and additionally have a set of agreed form documents which they are willing to lend on meaning the lending process is streamlined. In addition, we find mezzanine lenders generally have existing strong relationships with senior lenders, which serves to quicken the process and allows the developer to get quick access to the funds it needs, for example, to build-out the development.
Mezzanine finance is therefore an attractive proposition to a borrower due to its flexibility and ability to open up further revenue streams by reducing the developer’s own capital invested, therefore enabling investment in multiple developments at the same time.
By Yavn Brar
Head of Corportate & Commercial
Direct: 0118 989 9713
Mobile: 07971 588 364