Mezzanine financing is a unique way for a business owner to secure funds through an alternative lender. This lender agrees to make the loan without collateral in exchange for a share in equity or profit from the business. Mezzanine loans come through subordinate lenders; this means they are traditionally provided through private equity groups, mutual funds and other private investors. Because the loans come through these private investors instead of public companies, they are typically less affected by the general economic climate and are a great option during a recession.
Not Dependent on Credit Score
Senior loans, such as bank loans, are traditionally dependent on a business's financial history and credit score. For a new business, lenders will often evaluate the business owners own credit in order to determine if a loan should be extended. During a recession, many businesses and business owners take a hit to their financial stability. Senior loans can be hard to come by due to low credit scores.
When a lender evaluates other criteria for the loan, consumers without a large amount of financial stability will benefit the most. Mezzanine lenders often use the business plan of a particular venture to decide on financing. This means a business with a good chance of potential future profit may receive the funds even if that business does not have a record of profit. Using financial projections instead of financial records is the best option for a start-up or a business looking for funds to expand into a new area for profit. Mezzanine lenders are often ready to take more risk on businesses that show promise in the future.
Not Dependent on National Credit Market
While no lender is totally immune to changes in the national credit market, private lenders are less affected than public lenders. Public lenders will always have to answer to investors and a board of directors. In a recession, these investors and boards will want the lender to take less risky loans. This is the result of a failure of multiple loans in the recent past; when borrowers default in a recession, lenders pull back from risky loans for the time being.
Mezzanine lenders will still have less cash on hand during a recession. Your business model must be strong to secure this form of financing. However, mezzanine lenders will also be looking at the recession as an opportunity to expand into under-served new businesses and make a large profit when the economy picks back up.
Not Affected by Interest Rate Changes
The national interest rate will fluctuate during and after a recession. The prime rate will typically go down sharply initially, but it will likely adjust much higher in subsequent years. Businesses often take adjustable loans and credit lines because they take large loans that have a long life. Businesses put themselves at risk of finding a much higher interest rate than they anticipated when they take an adjustable loan during a recession.
A mezzanine loan does not have a straight interest rate like a senior loan. Instead, the profit and equity share of the company is used to pay for the loan. If the business does not meet financial projections after the recession, they will owe less on the loan.