Small and medium-sized businesses that want to grow and/or expand rely on outside capital. But banks are often reluctant to grant credit, especially when it comes to large amounts and little equity is available. Thus, one has the choice between investment and development stop or one takes a partner in the company, which increases the equity share, but in return is granted co-determination rights. Or you can opt for a mixed form of equity and debt capital: mezzanine financing.
The most important facts in brief
- Mezzanine capital is a mixture of equity and debt capital.
- Mezzanine financing is best suited for expansion projects of SMEs with a volume of at least 500.000 Euro.
- Mezzanine capital includes the "silent partnership", profit participation rights, subordinated loans, shareholder loans and convertible bonds or bonds with warrants.
- The right financing mix of equity and debt, subsidies and mezzanine capital is the key to success.
What does mezzanine capital mean?
"Mezzanine" comes from the Italian word "mezzo" and means something like "middle". "Means" because mezzanine financing is a mixed form of equity and debt capital.
There are several different types of mezzanine capital and each can be attributed more to equity or more to debt capital of the company based on its characteristics. On the balance sheet, these financings usually appear as debt capital.
The essence of mezzanine financing
Mezzanine capital is a form of financing without a say for the financier, but with a share in the company's success. What this participation looks like can be contractually arranged on an individual basis. However, all forms have in common that the repayment of the investment amount is not guaranteed. The mezzanine capital is treated as "subordinated".
This means that in the event of insolvency, all other creditors are serviced beforehand. Mezzanine forms of financing do not necessarily have to replace a bank loan. In most cases, it is the mix of several capital sources (equity, working capital loans, subsidies and subordinated loans, for example) that makes new investments successful. Banks are also more willing to grant investment loans if the company spreads the risk more broadly through several sources of financing.
Characteristics of mezzanine capital
Mezzanine capital can take many different forms, which we will explain below. However, they all have some characteristics in common:
- No voting rights for the investor: Whether silent partner or crowdfunding investor, there is no say or voting right for the financier in entrepreneurial decisions.
- Flexible contract options: There are hardly any legal restrictions on mezzanine financing. The structuring options are therefore flexible in terms of repayment, interest, term and other compensations.
- No security for the investor: Since mezzanine capital is a subordinated form of investment, the risk of total loss is much higher, since in the event of insolvency, the mezzanine capital provider is the last to be served.
- Long maturity: with the exception of some crowdfunding projects, mezzanine financing forms are characterized by a maturity of five years plus.
- Interest based on profits
For which projects is mezzanine financing suitable??
Already established SMEs, whose business model is successful and profitable, like to use mezzanine capital for expansion projects. They have the clear advantage of being able to present an attractive offer and a corresponding return to the investor. The mezzanine capital is characterized by the high amounts (from 500.000 euros) and a long term of at least five years.
In this context, experience in the business area and a profitable past are important, as the mezzanine investor otherwise fears the total loss of his investment due to the subordinate status. Only in crowdfunding projects is the company's performance in recent years less decisive. The low amounts of the individual private individuals make this type of mezzanine capital also interesting for start-ups. We will come back to the special form of "crowdfunding" below.
Mezzanine financing – what types are there??
The different types of mezzanine capital can always be assigned more to equity or debt capital, but always remain a hybrid form that only have a certain tendency in one of the two directions.
While the "silent partnership", "convertible bonds" and the profit participation right have more of an equity character, the subordinated loan and the shareholder loan have more typical characteristics of debt capital.
We explain the individual forms in detail:
Silent partnership
The "silent partnership" is probably the best known and longest established form of mezzanine financing. The investor becomes a "silent partner". The investor invests his money in a company and in return participates in the profit. Depending on the contractual arrangement, participation in the increase in value of the company is also possible.
The silent partner has no say in the matter, but must be granted access to the company's books. He therefore has the right to accounting information. The silent partnership is not registered in the commercial register and is therefore not publicly visible. There are also no formal requirements as far as the partnership agreement is concerned.
In contrast to other shareholders, the silent partner is only liable for the amount of his contribution. The investor has no company assets, the available capital is transferred to the company's assets. There are two different forms of silent partnership – typical and atypical:
The typical or true silent partnership provides that the silent partner participates exclusively in the economic result. Further influence is not envisaged.
Profit participation right
The profit participation right is widespread as mezzanine financing in German-speaking countries. In this case, the investor's right is securitized in the so-called profit participation certificate. Here, too, no voting rights are provided for, but a certain share in the company's success is determined on the basis of defined key figures. In addition to profit sharing, the investor also has a claim to repayment in the amount of the nominal value.
Special forms also provide for contractually fixed interest payments instead of profit sharing, which, however, are also only paid out under certain conditions, such as a positive annual financial statement. The profit participation right and the profit participation certificate differ from the silent partnership mainly by the profit dependence. In the event of losses, the repayment amount may in fact be reduced. Interim profits in turn can compensate for these losses.
As with all types of mezzanine capital, investors must expect a total loss of their investment if the company becomes insolvent. Although profit participation certificates are often issued by listed companies, they are by no means limited to them.
Subordinated loan
A subordinated loan has a very strong debt character. It is a financing with a fixed term, agreed interest and repayment. As the name implies, this mezzanine capital is also treated as subordinated capital. In other words, in the event of insolvency, the creditor only receives his money when all other liabilities have been settled.
Two forms of subordinated loan are typical for mezzanine financing:
- The partiaric subordinated loan, in which the lender is entitled to a profit participation.
- The qualified subordinated loan, where the lender can expect a fixed interest rate. It should be noted, however, that the company is exempt from the interest obligation if this would lead to liquidation problems or even insolvency.
At the end of the fixed term, the nominal amount is paid back to the investor.
Shareholder loan
Similar to the subordinated loan, the shareholder loan also tends to be classified as debt capital. The simplest form is for a shareholder to provide capital to his own company for an agreed interest rate and for a defined term.
At the end there is the repayment, if necessary and with mutual agreement, the term can still be extended after expiration. There is also the possibility of extending the company loan by a profit share. This changes the character of mezzanine capital in the direction of equity capital.
Convertible bonds or bonds with warrants
Bonds are investments in a listed company. There are also government bonds, but they do not play a role in this context. Unlike the purchase of shares, this does not involve the acquisition of a share in the company, but rather the granting of a loan to the company. With a fixed term and at certain conditions in terms of interest and repayment. Bonds are therefore borrowed capital that comes from several small investors instead of one large creditor.
Convertible bonds, however, are a very special form of bond that is extended by an important option, namely the "conversion right": from a bond into a share in the company. Within an agreed conversion period and at defined conditions, the capital provider can convert its bonds into shares. Bonds usually have low interest rates and are therefore less attractive as a form of investment. The possibility of increasing the low interest rates through possible dividends and benefiting from the increase in value of the company in the event of conversion makes this mezzanine financing more attractive.
For the entrepreneur, in turn, this type of mezzanine capital has the advantage that after the conversion of the bond into the share, there is also a balance sheet shift from debt capital to equity capital. We have summarized further information on the conversion option on this page. Option bond and convertible bond differ in that the option bond always exists until redemption. Investors receive additional purchase rights with the option bond to acquire shares.
The option rights can be split off and traded separately on the stock exchange. The advantage of both forms of mezzanine capital for capital providers lies in the relatively low risk of loss of the bond and the additional profit opportunities through the share purchase and conversion options.
The advantages and disadvantages for entrepreneurs
The Mezzanine capital has like each other financing form its advantages and disadvantages. The main reason for mezzanine financing is often that the bank does not grant the loan or not to the appropriate extent.
In favor of mezzanine capital:
- Financing from outside
- No say of the investor, the investors
- Long-term financing
- A great deal of flexibility in the financing agreement, as there are hardly any legal restrictions
- Improved creditworthiness and rating with banks
- Wide range of investors, as any private person can also be an investor
The disadvantage, in turn, is:
- High capital costs due to the risk of loss
The advantages and disadvantages for investors
Mezzanine financing also has advantages and disadvantages from the investor's point of view. The advantages that should be emphasized as an entrepreneur to the potential lender are:
- Any private person can become a mezzanine investor. This makes it possible to achieve a return without a background in economic mathematics or knowledge of the capital market.
- Straight one in the current low-interest phase, in which some banks require already negative interest for the "money storage", can one its money for itself work, if one appears as Mezzanine Kapitalgeber.
- The interest rates are – depending on the form of capital – high. In any case, they should be above current inflation.
- You have the chance to directly choose a company or a project you can really identify with.
- Through good negotiation, there is room for better terms with certain forms, as mezzanine forms of capital are not in a tight legal corset.
- You are only liable with your contribution.
The disadvantages for the private investor are:
- Risk of total loss, as mezzanine capital is always subordinated.
- No say in business decisions.
- The capital is tied up for the long term.
Special form: Crowdfunding
Because crowdfunding or crowdinvestment is on everyone's lips right now, we want to take a closer look at this option from the perspective of mezzanine capital. Crowdfunding means nothing more than that a large number (crowd) of private individuals financially support a project and can expect a return on investment in return.
Unlike other mezzanine financing, crowdfunding is often used in the start-up phase of companies or to implement innovation and expansion projects in SMEs. Crowdfunding usually runs through a crowdfunding partner, which offers the project as an investment within its platform. While other common mezzanine financings require a minimum amount of about 500.While the amount of the investment is limited to a maximum of 000 Euro, the crowdfunding is also suitable for smaller amounts.
The term does not have to be at least five years, but adapts to the realistic repayment horizon. Crowdfunding is particularly suitable for projects that are easy for the masses to understand. Especially in the B2C sector, it also makes sense to provide investors with "goodies" from your own production or service in addition to the return on investment. Particularly popular are also "early bird" bonus systems, where early investors can expect higher returns.
Here are some of the currently most popular crowdfunding platforms:
The Rocket platforms with www.greenrocket.com, www.homerocket.com and www.lionrocket.com
www.conda.eu
www.finnest.com
www.rendity.com
www.dagobertinvest.atNew crowdinvesting platforms are constantly appearing on the market, often specializing in very differentiated industries. A good overview list can be found on the WKO site.
How can I finance as an entrepreneur by means of crowdfunding?
An entrepreneur who wants to finance a project through crowdfunding needs a business plan for the entire term even before signing a contract with a crowdinvest partner, stating how he plans to earn the interest payments due as well as the redemption after expiration. Before the crowdfunding platform offers the project, the business design is carefully reviewed.
It is also important that you as an entrepreneur are clear about the amount you need to start the project. This minimum amount is called the "funding threshold". If not enough investors are found to exceed the funding threshold, the investors get their capital back and the crowdfunding does not come to fruition.
Advantages and disadvantages
In addition to the usual advantages and disadvantages of mezzanine capital, crowdfunding is characterized by some special features.
Advantages are:
- By positioning the brand on crowdfunding portals, the company automatically receives a large reach in communication.
- By giving goodies such as vouchers or sample copies, one can already build customer loyalty through funding.
- The processing is done by a crowdfunding partner, one has little work with the capital contribution itself.
The disadvantages, in turn, are mainly financial:
- Due to the high risk of default for the investors, very high returns are expected. 6% to 7% is not uncommon. So the capital is much more expensive than an investment loan.
- The crowdfunding partner also wants to be remunerated for his service.
Crowdinvestments are often subordinated loans, but profit participation certificates are also conceivable as a form of implementation. The topic of crowdfunding is very extensive and difficult to understand. Independent financing specialists can help you find the right partner for your project!
Find mezzanine investors
The different financing options make it quite cumbersome to find the right financing partner for the planned project. In addition to the crowdinvesting platforms mentioned above, there are also specialized private equity investment funds and funding agencies that can assist in finding mezzanine capital providers. But banks themselves can also provide access to private investors.
The Business-Angels-Network is another point of reference. The simplest method, however, is to turn to an independent financing specialist, who takes care of all the bureaucratic hurdles of generating capital, right up to the settlement with the crowdfunding partner.
The right financing mix
In very few cases is mezzanine capital sufficient to finance a project or even a start-up company. It is therefore important for entrepreneurs to find the right mix of equity, subsidies, debt capital and hybrid forms of financing. It requires a great deal of information and time to ensure that the individual capital wheels mesh together perfectly.
Independent financing specialists help not only to find a mezzanine capital provider, but also to create the right conditions so that the interaction of banks, private financiers, funding agencies and owners contributes to the success of the company.
CONCLUSIONS:
Mezzanine capital as a springboard for innovation
Mezzanine financing lies somewhere between debt and equity in terms of its economic orientation. Mezzanine capital exists exclusively for companies and makes (with the exception of crowdfunding) for project sums from 500.000 Euro sense. It is always subordinated and is more expensive for the entrepreneur than an investment loan from the bank. However, it is an alternative way to finance expansions or projects that the bank does not (or not fully) support.
The main instruments are the silent partnership, the profit participation right, the subordinated loan and the shareholder loan. Companies listed on the stock exchange still have convertible bonds and bonds with warrants at their disposal. The currently very popular crowdfunding also belongs to the category of mezzanine capital, although it has some special features.