If you’re considering a large-scale business purchase, such as property, or planning a business acquisition or management buyout, you’ll naturally look to loans or external investment. However, mezzanine financing combines debt and equity finance as a way to bridge funding gaps.

In this guide to mezzanine finance, we break down the pros and cons, the steps involved and how it compares to other alternative funding options, like flexible business loans, bridging finance and peer-to-peer lending. 

What is mezzanine financing?

Mezzanine finance is a specialised form of business funding that mixes debt and equity finance to help companies meet their funding targets and enjoy the benefits of both methods. This hybrid approach allows you to borrow more than you’d normally be able to by securing the lender's stake with an option for them to convert the loan to equity – say, if you were to default on repayments.

This form of finance is often used in real estate, leveraged buyouts and acquisitions, to help fund expansion and project development. A business typically uses mezzanine finance to provide additional funding beyond standard loans or existing equity investments.

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Comparing mezzanine finance with debt and equity finance 

Most businesses raise funding from two primary sources: capital borrowed from a financial lender and money put up by the business owners or pledged by investors. These are typically defined as debt finance and equity finance.

Mezzanine finance vs debt finance

Debt finance can be provided as a loan, advance or line of credit, with varying repayment terms and interest payments. Both the business and lender know what payments are due and when the debt will be cleared. For secured borrowing agreements, if your business fails or defaults on repayments, the lender will be the first line to recover its funds from the sale of the business assets.

Mezzanine finance can ease the burden of debt finance, enable you to get higher funding amounts and provide options to negotiate equity arrangements within the agreement.

Mezzanine finance vs equity finance

Equity finance comes from firms or individuals willing to invest in your business, primarily to turn a profit and get a return on investment. As your business grows, the value of the equity increases. 

You can receive funding from investors in exchange for a share of ownership, control, profits and losses. If the company goes under, equity holders (shareholders) get what's left after any debt has been paid off.

Combining elements of debt and equity funding, mezzanine financing offers flexibility, fall-back options if things don’t go to plan, while boosting borrowing amounts. 

A hybrid financing model for real estate and acquisitions

Taking its name from the Latin word for middle, mezzanine capital sits between senior debt and shareholder equity. The structure of the loan is flexible and tailored to your business. Rather than securing the debt against business assets or a personal guarantee, mezzanine finance lenders are banking on the business' future to reduce risk levels. 

Often referred to as mezzanine debt, agreements often include rights to convert debt to equity at a future date or when certain conditions are met.

Key mezzanine finance use cases

There are various reasons to turn to mezzanine financing to fund your business needs, but the most common use cases of this method are: 

• Leveraged buyouts: Mezzanine finance can bridge the gap between debt and equity, enabling buyers to complete a purchase with less upfront capital.
• Acquisitions: Funding can be used to acquire another company without immediately diluting ownership or taking on more rigid senior debt solutions.
• Expansion/scaling: Mezzanine capital helps businesses fund key growth initiatives, such as entering new markets or expanding operations.
• Property development: Developers can use mezzanine funding to top up loans, covering construction costs until projects are completed and properties tied to lending agreements are sold.

Mezzanine finance example

The best way to understand how mezzanine finance can be leveraged is for it to be explained with an example. Here’s how this funding method can play out:

• You're eyeing an acquisition target valued at £1 million. Your bank agrees to a standard business loan of £750,000, but you need another £250,000, and you only have £100,000 available. 
• You need another £150,000, and you don’t want to miss out on this deal, so you talk to a mezzanine finance provider, who offers you the extra £150,000 at a relatively high interest rate with the condition of converting the agreement into equity if, in the future, you’re no longer able to repay the debt.
• By taking on mezzanine debt for the other £150,000, you can bridge the gap between the funding you already have and the funding you need for a specific project or venture, and close the deal rather than missing the opportunity.

Mezzanine finance can also play a key role in helping you secure your primary sources of funding. Providers of mezzanine capital tend to be vested in the success of your business, often for the long term.

Why use mezzanine financing?

Mezzanine financing offers several strategic advantages for entrepreneurs and businesses looking to fund large commercial purchases or expansion plans, but there are downsides to consider. Here are the main pros and cons of the method:

Key benefits of mezzanine finance

• Business owners can leverage a higher potential return while putting up less capital themselves.
• Helps prevent missing commercial opportunities due to a funding gap.
• If the extra capital helps your businesses grow faster, you have the flexibility to restructure mezzanine debt into a more traditional loan at a lower rate.
• Mezzanine debt may include “PIK toggles” – a type of arrangement where you can defer interest payments or add them to the loan balance.

Drawbacks of using mezzanine finance

• Mezzanine financing comes with agreed financial strings, such as warrants and options, so you must be comfortable potentially diluting your share of equity and future value in certain circumstances.
• If you default on the loan, lenders may opt to sell or transfer their stake, leaving you with new equity partners.
• As mezzanine funding is “subordinated debt”, it can restrict how you manage your credit, expenditure and cash flow.
• Compared with a pure loan, mezzanine financing is more complex and takes time to arrange, meaning it can be weeks before you can access the capital.

Mezzanine finance pros and cons at a glance

Mezzanine finance alternatives

Mezzanine financing can be a good source of additional capital for established businesses seeking growth through acquisition, buyouts, property development and other major commercial projects and new ventures.

For business owners with less aggressive growth plans, other forms of funding or alternative business finance may be more suitable, including dedicated real estate finance solutions. Here are the main mezzanine finance alternatives to consider:

• Commercial mortgages: For spreading the cost of purchasing or refinancing business premises over a long period, giving you lower interest rates than most other solutions.
• Development finance: Used to finance property construction or premises refurbishment, with funds released in stages throughout the project.
• Auction finance: A specialised finance option offering quick access to funds for businesses to complete property purchases within tight auction deadlines.
• Bridging finance: A short-term funding solution to bridge funding gaps, typically for real estate purchases, until longer-term finance is arranged or properties are sold.
• Asset finance: Funding agreements to spread the costs of acquiring and hiring business assets, such as equipment, heavy machinery or vehicles.
• Peer-to-peer (P2P) lending: A way to match with various individuals willing to lend money towards your funding targets via lending platforms, with repayment terms agreed online.
• Flexible business loans: Fast and flexible unsecured loans, usually offered by digital lenders, like iwoca, with simple online applications and approvals and tailored repayment terms.

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Weigh up the pros and cons of mezzanine finance and other debt finance alternatives, comparing speed of funding, amount and length of capital required, flexibility offered and fees/costs of borrowing.

If you want a fast and flexible short-term funding solution, offering significant capital with repayment terms tailored to your needs, look no further than iwoca Flexi-Loans.

You can borrow between £1,000 and £1 million for a few days, weeks or up to 60 months, only paying interest on what you draw down, with the option to repay early free of charge. 

Apply for an iwoca business loan in minutes and get a funding decision within 24 hours. Check out our handy loan calculator to see your likely repayments.  

Mezzanine finance FAQs

What is mezzanine finance in real estate?

Mezzanine financing in real estate helps bridge the gap between loans for property purchases or development projects and existing equity, providing extra capital without giving up ownership (unless you experience financial difficulties in the future). It allows flexibility in development projects, such as deferred or interest-only payments, and the conditional equity element reduces lenders’ risk level, unlocking additional funds to cover unexpected construction or legal costs. 

Is mezzanine finance secured or unsecured?

Mezzanine finance is unsecured in the sense that it doesn’t require business assets as collateral, but can be supported by a second charge behind senior debt, and lenders have equity conversion options if you encounter financial difficulties. As a subordinated form of finance, mezzanine debt usually carries higher interest rates than traditional lending and secured loans.

Can mezzanine finance be used by start-ups?

Yes, mezzanine finance can be used by start-ups, although, as with traditional debt finance, it’s not as easy to get approved due to a lack of business credit history and track record. However, due to the equity element in the funding agreements, it can be a trade-off for the risk involved in lending to new businesses. Mezzanine finance is better suited for later-stage start-ups, as if you’ve already got money coming in over a certain period, you have more proof of profitability. 

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