Mezzanine is an indirect instrument between indebtedness (eg taking a loan) and equity financing (eg issue of shares). This alternative source of raising funds for new investments is gaining more and more popularity among companies around the world.
A MODERN SOURCE OF FINANCING
Mezzanine is an instrument of external financing of entrepreneurs, which is defined as an increased risk. This is a response to the growing demand of enterprises for an alternative source of financing, which is secured by the company’s assets (eg loans secured against real estate) and at the same time involves positive cash flows. So far, such an instrument was missing from the financial markets, despite the continuous opening of new stock exchange markets for medium-sized companies. Currently, this niche fills up, and thanks to mezzanine, companies acquire investors who want to give them financial support in exchange for shares in the profits from the investments made, if they turn out to be successful. This type of activity secures the minimum income that an investor can achieve from the investment, while it does not specify the maximum profits that a risky investment can bring.
MEZZANINE IN PRACTICE
In practice, mezzanine resembles a long-term debt instrument, which is why the contract drawn up for this type of financing is similar to a standard loan agreement. The details of each contract are determined individually between the entities, but most often this type of obligation is repaid on a one-off basis at the end of the agreed financing period. Mezzanine is a product gaining more and more popularity due to the relatively small impact on the current receipts of the company, which pays only interest on the determined amount throughout the entire financing period. These small tranches usually constitute only 10-14 percent. the entire amount that must be settled by a company deciding on mezzanine. From 1 to 5 percent. amount is the so-called PIK (payment-in-kind), ie bonds and preference shares, from which interest or dividends can be paid non-cash, eg in the form of new securities. The rest of the total repayment amount is the capital part that allows the investor to participate in the growth of business value.
Mezzanine financing works best for medium and large enterprises that do not have sufficient capital to implement their intended investments. For example, large companies that want to obtain the funds necessary to take over another company with good financial condition. These risky investments absorb large sums that are difficult to make from the company’s budget without affecting its financial condition. Mezzanine finance is to a large extent intended for entities that face this type of dilemma.
EXAMPLE OF FINANCING IN PRACTICE
The Krakow-based company, operating for 9 years on the gastronomy market, has taken steps to develop its operations with new market segments due to the dynamic development of its operations. A great potential was recognized in the real estate industry and the constantly growing housing needs in the city of Krakow.
With an extraordinary building plot in its property, located on one of the most picturesque areas, enjoying great interest, including tourist attractions, an investment project was begun in the construction of semi-detached houses. The fact that the company had no previous experience in the development industry meant that the assumed budget was not sufficient to complete the investment. Until the end of the project, it was necessary to obtain additional funds in the amount of PLN 200,000, which will be able to top up investment capital in an instant and without unnecessary formalities.
The loan is to be repaid for the company from the funds obtained from the sale of the real estate, and the proposed pledge is a building plot in Krakow, where the investment is currently being implemented.