Are you a Property Developer struggling with state financing in Australia? Well one can go for mezzanine finance. This article will briefly explain to you what mezzanine finance entails and why it is profitable for the investors.
Mezzanine finance is the financing method which is considered to be intermediate between a debt and equity financing. It gives the investors a way through which they can mobilize other forms of finance to support their projects or expansion of their businesses. Because mezzanine finance has fairly relaxed working capital requirements than regular debt and the opportunity to earn a better return than could be received on straight debt, it is proving to be popular among investors.
The objective of this paper is to analyze how mezzanine finance is operated, the actors involved in the field and whether mezzanine finance is suitable for the Australian market. We shall also spend some considerable time with you explaining to you the advantages and the disadvantages of this option in the hope that you shall be able to make sensible investment decisions.
In Australia, this guide will help you particularly if you are a veteran of Property Developer or a new comer to the financial world to grasp enough information about mezzanine finance. Well, let us proceed further and unveil the features of this type of funding as the positive option for an investor.
What is Mezzanine Finance?
It therefore comes between a debentures and share capital and hence it is referred in as mezzanine finance. It is a kind of non-core debt instrument which stands below the senior claims and offers extra source of funds for corporate requirements apart from senior debt to meet growth, acquisitions or other business strategies. Mezzanine finance more often incorporates both debt and features similar to an equity for example convertibles or preference shares.
Mezzanine finance is structured in a manner to fill the gap of senior debt and junior equity where Investors gets a better rate of return than that of debt yet better than equity financing for borrowers. This double edged nature of mezzanine finance is the reason why many firms find it as a suitable means of finance that they may opt for instead of conventional bank loans or for the reason of retaining higher degree of control over their business.
To recap, I have established that although conceptualized as a separate class of securities, mezzanine capital falls in between debt and equity in the world of finance. It has some distinctly favorable features that is can be adjusted according to the requirements of borrowers as well as investors. Therefore, the use of mezzanine finance has continued to rise as a means of financing for organizations of all the sizes from various industries.
How Mezzanine Finance Works
The structures of mezzanine finance have elements of debt as well as equity. Usually, a mezzanine financing structure entails a subordinated debt, which is usually more expensive in terms of interest than a senior facility or claim, and equity kicker in the form of warrants or converted note.
In the capital structure, one mezzanine finance component is the subordinated loan which is ranked junior to the senior debt on the list of the organization’s obligations. To counterbalance this higher risk, the interest rate is higher, depending on the exact conditions set by the contracting banks and the creditworthiness of the borrower.
The equity kicker, for its part, gives the mezzanine lender the possibility to share the upside with the company’s growing business. This can include warrants which is an option that provides the lender with the right, but not the obligation, to purchase the company’s shares at a particular price or a conversion option enables mezzanine debt to be converted into equity at a certain time in the future. The equity kicker makes sure of the synchronization of the mezzanine lender and the borrower since they will both be on the same side with the company.
The ability to incorporate subordinated debt and equity like elements makes mezzanine finance a rather flexible financing instrument. The borrower obtains more capital than using regular senior debt, and the investor will have better CoD than a pure debt investment.
Advantages and Disadvantages of Mezzanine Finance
Lenders and shareholders both have their advantages and disadvantages as far as mezzanine finance is concerned. It is thus extremely crucial to appreciate them both when embarking on mezzanine financing as the method of financing.
Advantages for Borrowers:
to additional capital: Mezzanine finance offers an opportunity to big enterprises to secure a kind of a funding that is not restricted by traditional senior debt, hence can be useful for financing, growth, acquisitions or other activities.
Flexible financing terms: Compared to traditional bank loans, mezzanine financing is generally less rigid guaranteeing the repayment periods, and/or allowing the deferral of interest charges.
Preservation of equity ownership: Due to the fact that mezzanine finance enable the borrowers to raise capital cheaper than in the case of pure equity financing, it causes that the rate of equity ownership is not as heavily diluted as it could have been.
Disadvantages for Borrowers:
On the same note, mezzanine financing often attracts more costs than senior debts and therefore it makes up a larger proportion of the cost of capital.
Subordinated position in the capital structure: Due to the subordinated status of mezzanine debt it is ranked lower than other forms of debt and can be risky for the borrower in case of default.
Subordinated debt may be less flexible in terms of restricting the borrower’s operations and providing more frequent reports compared to the ordinary debt.
Mezzanine Finance vs. Traditional Debt and Equity Financing
Mezzanine finance thus falls somewhere between debt and equity financing or can be said to be simultaneously part of both. It becomes crucial for the investors and borrowers to know each of the differences in these financing techniques.
Traditional Debt Financing:
The finance cost, for example, bank loans or bonds are normally the outermost layer in a firm’s funding structure. Debt is backed by an asset and has the first charge, ensuring the original risk is lower and interest rate is also comparatively lower.
Equity Financing:
Such as venture capital or private equity investment means, the sale of equity interest in the company to the investors. It is usually characterized by a higher risk exposure but also elevated returns because the investors draw equity from the company’s growth and level of profitability.
Mezzanine Finance:
Mezzanine finance takes a middle ground between senior debt and equity with some of the characteristics of the two.
It is ranked below senior debt and offers a lower interest rate, nevertheless, mezzanine debt contains an equity kicker reflected in warrants or a conversion option.
These are mainly differences in the risk/return characteristics, position in the capital structure and control and ownership rights that the financiers are offered. Thus, borrowers and investors should consider these two types of financing to come up with a proper balance and decide on the best funding strategy to use.
Mezzanine Financing in Australia: Market Overview
The market of mezzanine finance in Australia has recently experienced considerable growth due to the positive résultats of such kind of financing for both – borrowers and investors. Some of the factors that spur the market include the search for more capital by firms beyond what local banks can offer and investors’ desire to have new opportunities for investment to earn high returns.
Down one of the most important factors that determine the potential of the Australian mezzanine finance market is the relative stability of the economy of Australia and high development of Private Lending. Australia has experienced a robust economy, politically stability, and legal framework of the country has continues to encourage the domestic and international investors many of who are in search of new form of investments such as mezzanine finance.
Moreover, the current Australian banking practices are rather conservative especially in terms of credit risk as it changed after the global crisis. This has led to a new form of financing emerging to fill this void in the market hence, mezzanine finance has opened an opportunity for business financing for those who wish to expand their businesses.
The market structure in Australia can be described as a variety of true mezzanine finance funds, pure PE firms and Private Lenders. These players bring in several types of mezzanine financing products depending on the borrower’s needs and industry of operation including real estate industry, infrastructure industry, manufacturing industry among others.
Conclusion: Is Mezzanine Finance Right for You?
Mezzanine finance has been noted most recently as one of the most popular and attractive forms of financing in Australia, as it gives both sides of the transaction, the borrower and the investor elements of both debt and equity financing. In case of mezzanine finance investments that you are as an investor willing to make, it is essential that you look into factors that may include your investment goals, tolerance to risk, and your total investment plan.
If you consider expanding your investment portfolio, possibly earn a better return than most debt securities and do not mind slightly higher risk, mezzanine should be in your list of considerations. That part of the mezzanine financing which actually enables investors to share in the value added of the borrower’s business through the equity kicker feature may also go down as a great selling point of the mezzanine finance.
Yet, it is crucial for recognizing many threats and issues that are implied in mezzanine finance including credit risk and its mitigation, the risk of illiquidity, and the problem of estimation of the mezzanine finance value. Recognising the opportunity, investor’s credit evaluation of the borrower and the understanding of complex mezzanine financing structures are critical evalutors in the mezzanine finance.
In conclusion, it is prudent to consider the objectives, risk appetite and particularities of a diversified investment proposition against the opportunity of investing in mezzanine finance. Thus, studying the specifics of the Australian mezzanine finance market and relying on knowledgeable specialists, investors have the opportunity to expand the list of directions for diversification and receive higher yields in their investment portfolios.