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How to buy a business with mezzanine financing

Mezzanine financing is a great tool to add flexibility to your capital structure

3-minute read

Acquiring a business can be a smart way to grow your company. But it can also pose financing challenges for your business.

Typical sources of capital for an acquisition are the buyer’s investment, secured debt from a financial institution and vendor financing. To fill out the package, many entrepreneurs also turn to mezzanine financing.

Mezzanine financing, also called subordinate financing, is a hybrid of debt and equity that isn’t secured by specific company assets. Instead, it’s based on historic and expected future cash flows of the company.

Financing options when building your capital structure for an acquisition

Term debt
  • No equity dilution
  • Generally lower cost
  • Strict repayment terms
Mezzanine financing
  • Flexible repayment terms
  • Maximizes the total leverage
  • No equity dilution
  • Can finance unsecured intangible assets
  • Requires positive cash flow
  • More expensive than term debt
Vendor financing
  • Generally lower cost
  • Keeps the owners engaged in future success of the business
  • Vendor notes can sometimes hinder acquirer’s growth plans
Minority equity
  • Patient capital
  • Partner shares the risk with the acquirer
  • Access to network and expertise
  • Ownership is diluted

Offers highly flexible terms

While interest rates are higher than for secured loans, mezzanine financing, or subordinate financing, offers highly flexible terms and requires little or no collateral.

It also often proves advantageous because it’s treated as equity on the company’s balance sheet, helping companies get easier access to financing from other financial institutions.

Here are some additional details about mezzanine financing and how to use it.

  • Increased flexibility

    One of the strengths of mezzanine financing is flexible repayment terms, which can be of crucial importance in an acquisition. The flexibility can help ensure your business has enough cash on hand during the often challenging initial period after the purchase, when risks of disruption or underperformance are greatest. Repayment terms can be customized in creative ways to each company’s unique needs, making this a patient form of capital. For example, some lenders will allow you to delay repaying the principal portion of your financing.

  • Based on cash flow

    Mezzanine financing can also increase your flexibility because it doesn’t rely on specific assets as collateral and usually requires limited or no guarantees. Instead, it’s based on the company’s historic and expected cash flow.

  • Avoids equity dilution

    Mezzanine financing can be structured so there is no dilution of the owners’ equity stake. This allows entrepreneurs to maintain full control of his or her business.

3 tips on financing your acquisition

1. Get advice early

The mix of financing can dramatically alter the return on the acquisition and the buyer’s risk. That’s why experts advise entrepreneurs to get advice early on in the process.

Getting financial partners involved at the beginning gives you time to negotiate an optimal financing package and helps ensure you’re ready to go as soon as you find a good acquisition target.

2. Cover your needs

Be sure to arrange enough financing to cover costs of integrating the acquired company. Inadequate financial resources often imperil acquisitions and have an impact on your entire company. Costs can be higher than budgeted, while revenues and synergies tend to lag expectations. Be conservative in your forecasting.

3. Communicate

After the transition, stay in touch with your financial partners. It’s important to keep them abreast of developments in the business. Get their perspective on challenges with the acquisition and discuss any needed changes to your repayment schedule.

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