Despite the pleasing uptick in business confidence, there is still evidence of distress in the property markets. Here’s how you can get a handle on finances in these challenging times.
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Property developers and investors looking for growth capital are turning to mezzanine financing as an alternative to senior debt or equity finance.
What is mezzanine finance?
Mezzanine debt is the middle layer of capital that falls between secured senior debt and equity.
This type of capital is usually not secured by assets and is lent based on a company’s ability to repay the debt purely from cash flow. So, the primary security holder would be the base finance secured against assets and personal securities – most often from the banks.
Unlike equity finance, where investors have an active interest in the company in order to see their share value increase, mezzanine finance is granted based on a company’s current and future cash flow.
Related: How to start small and succeed in commercial real estate
Why is mezzanine finance of interest in the current climate?
We are noticing a strong interest in mezzanine finance. There are good deals to be had in the current property market and many companies are looking to take advantage of them, but they may not have the capital to do so. Moreover, companies are often hesitant to give away equity in their business.
Who would choose mezzanine finance?
This type of finance is ideal for higher-value property investments or development deals of more than R50 million.
Typically, these deals involve a group of investors such as a property fund. By way of example, we had a client in Johannesburg that found an office block on sale for R100m. Although this was an attractive deal, their bank could only fund 70%.
Unwilling to opt for the more expensive equity finance option, the client came up with 20% of their own capital. We helped them find mezzanine funders which contributed the final 10%, without which the deal would not have been closed.
The upside is that they didn’t have to give away equity and were still able to move quickly on the opportunity.
What’s in it for the lenders?
Mezzanine lenders see the upside in their returns. For this reason, a mezzanine lender takes a more ‘arm’s length approach’ to operations than a senior debt lender or equity investor. So long as the company can service the loan and remain within the pre-determined covenants they are happy. Should the borrower begin to have difficulties, the mezzanine lender will often work with the organisation to try improve their outlook, before they call in the loan.
Related: The value of owning property if you have your own business
Areas for caution when going for mezzanine finance
The primary bond holder (the banks) need to sign off on mezzanine finance. There has to be agreement between lenders on how defaults will be managed, should they arise. Paragon works closely with clients to help them structure mezzanine finance in a way which gives primary debt lenders peace of mind. Although mezzanine finance is huge in the USA at the moment, lenders in South Africa remain more cautious.
It makes good sense to work with an independent lender to ensure your company has considered all the finance options as well as the hundreds of financiers before settling on way to finance your company’s growth.