Essay on Mezzanine Finance Explained

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Mezzanine Finance by Corry Silbernagel Davis Vaitkunas Bond Capital With a supplement by Ian Giddy Mezzanine Debt--Another Level To Consider Mezzanine debt is used by companies that are cash flow positive to fund: further growth through expansion projects; acquisitions; recapitalizations; and, management and leveraged buyouts. When mezzanine debt is used in conjunction with senior debt it reduces the amount of equity required in the business. As equity is the most expensive form of capital, it is most cost effective to create a capital structure that secures the most funding, offers the lowest cost of capital, and maximizes return on equity. Mezzanine debt has been around for over 30 years, however its use in Western Canada and the…show more content…
Although it makes up a portion of a company's total available capital, mezzanine financing is critical to growing companies and in succession planning in recent years. The gap in funding between senior debt and equity is common for the following reasons: 1) accounts receivable, inventories and fixed assets are being discounted at greater rates than in the past for fear that their values will not be realized in the future; 2) many balance sheets now contain significant intangible assets, and, 3) as a result of defaults and regulatory pressure, banks have placed ceilings on the amount of total debt a company can obtain. While additional liquidity can be obtained from equity investors, equity is the most expensive source of capital. Further, equity capital, by its nature, dilutes existing shareholders. As a result, mezzanine debt can be an attractive alternative way to obtain much needed capital. Capital Structures While there are no hard and fast rules for optimizing a company’s capital structure, companies that are ahead of the curve use an efficient combination of senior debt, mezzanine debt, and equity capital to minimize their true cost of capital. COMPANIES WITH EFFICIENT CAPITAL STRUCTURES EMPLOY A NUMBER OF CAPITAL SOURCES Expected Returns (%) Typical Private Equity Structure (% of total Assets) Senior Debt and Asset Backed (Stretch) Lending 30% - 60% 5% - 12% Mezzanine 20% - 30%

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