Access to finance is one of the most prevalent challenges facing entrepreneurs and business owners across developing markets. Local banks have traditionally focused their lending on large companies – in part because they view smaller firms as having insufficient assets or collateral. Even when bank debt is available, it is often short term in nature and does not provide the patient capital small and medium enterprises (SMEs), including Black Economic Empowerment (BEE) transactions, require to grow. Private equity may be one viable option but entrepreneurs and BEE beneficiaries are often reluctant to give up equity. In such cases, mezzanine financing may provide the solution.
Mezzanine financing encompasses a wide range of debt and equity positions that can be structured in a variety of ways to finance existing companies. In its most basic form, mezzanine capital is a subordinated debt instrument that is positioned in a company’s capital structure below senior debt and above common equity. In other words, in the event of default, mezzanine lenders stand in line behind all senior loans or obligations but ahead of equity holders.
The following diagram illustrates the position of mezzanine finance in a typical capital structure: