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What is a Mezzanine Fund?

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  • Written By: K. Wascher
  • Edited By: Daniel Lindley
  • Last Modified Date: 03 November 2016
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A mezzanine fund is a financial instrument that provides financing to a business or corporation. This type of financing is generally available to larger private and public companies such as large-scale construction projects, start-up companies in growth industries, and leveraged buyouts. There are a variety of additional scenarios where a mezzanine fund may finance a company; however, the investment criteria that many mezzanine funds have adopted are better suited for these particular uses. Loans made through a mezzanine fund are typically issued on top of an existing debt. Therefore, in the event of a default on mezzanine fund financing, other debts will receive priority payments and the mezzanine fund will generally be entitled to receive residual funds left over after all other debts have been paid.

Mezzanine funds are often used when a real estate firm contracts to make a sizable investment in properties such as a shopping mall or a large office building. Start-up companies that display a high probability of earning substantial profits or leveraged buyouts from a reputable company in a profitable industry can also benefit from mezzanine funds. This type of financing is generally issued with higher interest rates in the 20 to 30 percent range. Some mezzanine funds will finance amounts as low as $1 million US Dollars; however, most prefer to work with much larger sums due to the complexity of the transaction and the amount of paperwork required.

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Mezzanine funds typically offer unsecured financing based upon equity in the company, such as preferred stocks, rather than attaching a lien to another source of collateral. While traditional funding sources that acquire equity as collateral may seek an active role in the control and management of a company, mezzanine funds tend to take a more passive role. The primary goal of a mezzanine fund is to make loans to companies that will become profitable over time. The equity shares that the fund acquires are issued at a set price, with the expectation that the company will become increasingly more profitable over time, thereby increasing the eventual profits for the fund.

Another advantage of these types of funds for businesses is that the payout on the principal of the loan is generally not expected until a specified due date. This is where the expectation of proven performance and the high expectations of growth for the company come into play. By the time the principal is due, the mezzanine fund generally expects a substantial increase in the value of the business. Having an extended time for repayment may make this a worthwhile option for some companies; however, this also means that compound interest will make up a large part of the principal that is required to be repaid.

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