Mezzanine Financing –
simply explained

Key facts at a glance:

• Mezzanine financing combines aspects of both equity and debt capital.

• It can improve the equity ratio, and claims are often treated as subordinated.

• Financing arrangements such as silent partnerships or participation certificates also have disadvantages: the lender must share in the profits, the financing is often expensive and only available on a long-term basis.

• In day-to-day business, business loans such as those arranged by Teylor are often a sensible alternative: flexible and without profit sharing.

What Does Mezzanine Financing Mean?

Mezzanine financing occupies an intermediate position between equity and debt capital. Depending on the design of the respective agreement with the capital provider, the financing can take on characteristics of both capital forms. In this article, we explain the special features of mezzanine financing and describe typical forms such as silent partnerships or participation certificates.

Companies constantly face challenges: a firm urgently needs to invest in growth but has already exhausted its credit potential. Or: an established company has spread its own resources across many projects and now needs equity to advance negotiations with its bank.

Is it worthwhile for SMEs to consider mezzanine financing? We explain this financing type and describe examples such as silent partnerships.

Mezzanine Financing: Examples from Practice

Mezzanine capital can take many different forms and characteristics. But what does this mean concretely for companies and their financing needs? To shed some light on this, several models from practice are described below. These include silent partnerships, participation certificates, and convertible and warrant bonds.

Silent partnerships

In a silent partnership, investors provide capital with equity characteristics to a company but do not appear as shareholders. In plain terms, this means they forego any say in the management of the company.

In return for their capital contribution, they typically receive not only a fixed interest rate but also a variable profit share. Typical of mezzanine capital: the provided funds also function here as subordinated loans relative to the credits of other debt capital providers.

Despite the legal rules governing silent partnerships, there is relatively flexible scope in the design of individual contracts. Therefore, silent partnerships also appear in various forms, which are closer to either equity or debt capital financing.

There are also models in which capital providers receive a say in the company, assume liability and share in losses. In these atypical variants, the transition to a "genuine" shareholder participation can be fluid. This also undermines the benefit of mezzanine capital: obtaining funds that have the advantages of equity financing without granting new shareholders a say.

Participation certificates, convertible and warrant bonds

Participation certificates: When a company issues such certificates to a capital provider, it grants them shares in the company in the form of securities. These entitle the holder to a share in the company's profits or in the proceeds from its liquidation and can be resold. A say in the company is usually excluded. Participation certificates are classified as equity when they entitle their holder to share in both the profits and losses of a company and are set up on a long-term basis. Participation certificates are usually very complex and there is a lack of clear legal requirements. In SME financing practice, this form of mezzanine financing is rather rare.

Warrant bonds: These are bonds that provide their holders with additional rights. When a capital provider acquires these from a company, they are entitled to purchase its shares. However, the time window for the purchase is limited. Moreover, the number and purchase price of the shares are fixed. Once the option has been exercised or has expired, the bond itself remains valid: it provides the capital provider with interest income and must be repaid by the company at the end of the term. Securities are usually issued on a long-term basis — often for ten years or more.

Convertible bonds: Such bonds can be converted into shares under pre-agreed conditions. The deadline and the ratio at which the securities can be exchanged are also contractually fixed from the outset. Once the conversion has been completed or its deadline has passed, the bond continues to exist here as well. The company must therefore pay regular interest and repay the loan at the end of the term. Convertible bonds, like warrant bonds, are only issued by public limited companies. For many SMEs, these types of mezzanine financing are therefore not an option.

Based on the examples described, it becomes clear how complex the subject of mezzanine financing is. Some forms certainly offer potential for medium-sized entrepreneurs. However, for the challenges of day-to-day business, many are simply too long-term or too complex. For financing short-term orders, unforeseen events or seasonal peaks, other models are better suited.

Advantages of Business Loans over Mezzanine Financing

Day-to-day operations often require flexibility or short- to medium-term financing. Raw materials need to be procured promptly, a difficult season needs to be bridged, or lucrative cash discounts in procurement need to be secured. In such cases, fast and practical solutions as well as timely availability are what count.

In such situations, business loans such as those arranged by Teylor can demonstrate their advantages. Thanks to the fully digital lending process, loan applications are processed precisely and swiftly. This gives SME entrepreneurs an immediate perspective and allows them to plan concretely. Moreover, the terms for business loans are flexible and disbursement can usually follow very soon after a positive decision.

A major disadvantage of some mezzanine financing arrangements is avoided with Teylor's solution: business loans require no profit sharing whatsoever. With interest and repayment, the obligation is fully settled.