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Loan vs. Equity vs. Mezzanine financing: which is better for your business?
Imagine your business urgently needs funds, and you get the following financing options:
Which would you choose?
Wait… wait…. Wait. Before you answer that, why not read this article till the end? At least, so you can know what you’re getting with your choice.
Oh, and in case you didn’t notice, option #1 is what you’ll call a loan, option #2 will qualify for equity funding, and option #3 is more or less mezzanine debt financing.
Loans for business: Pros and Cons
When it comes to business financing, loans are the first option people run to. But are they really the best option? Let’s find out.
Pros of Loans
One of the biggest perks of loan financing is that you won’t be trading the ownership of your business.
Whether you want to fund a new project, acquire new equipment, or expand your workforce while waiting for your customers to pay up, you can easily take loans to stay afloat.
There is no limit to how much loan you can take. Provided your business has sufficient credit to access it.
Cons of Loans
You may struggle to find a lender willing to borrow you money.
If at all you do find a lender, it might take a while to get your loan approved.
Paying back to the lender will definitely reduce the amount of spare cash you have for the loan period. Meaning you may not be able to push other stuff like expansion, new acquisition, etc., until the debt is done.
Failure to repay a loan can result in the lender seizing your asset.
Equity funding: Pros and Cons
This one refers to an angel investor coming in to fund your business without requesting any repayment in return. However, he asks for a certain percentage of your business.
Pros of equity funding:
You won’t pay back any money you receive.
Even if the business fails, you won’t be obliged to pay back the investor. It’s their loss.
Cons of equity funding:
The biggest drawback of equity funding is that you lose a certain percentage of your business to people that didn’t begin the whole journey with you.
What this means, in practice, is that you no longer have the final say over your business operations, and you don't own the entirety (100%) of profits. You will share profits with them according to an agreed percentage, and they can argue/contest some of the business decisions you take.
Mezzanine Financing: Pros and Cons
This type of financing is a hybrid of loan and equity financing. That is, it’s a type of financing option that combines debt-like features with equity-like features.
How does Mezzanine financing work?
How it works is that you take out a mezzanine loan from a lender (like a traditional loan). Then you start paying back a certain sum, maybe monthly or quarterly.
However, it differs from traditional loans because it is typically interest-only, with the principal due at the end of the loan term. But in the event you fail to repay the loan fully or default in interest repayment, you may have to give out a certain percentage of the business (equity) to the lender. This is where the equity-like features come in.
Pros of mezzanine financing:
If banks are unwilling to offer the amount of money your business needs, you might easily find a mezzanine lender willing to meet your target funds.
Unlike outright equity financing, mezzanine financing may not even reach the point where you have to give out your business equity. And even if you have to, the percentage is usually not as significant as regular equity financing, which means you'll still have higher control over your business.
Most lenders may not be willing to borrow you money if they see you're currently servicing a traditional loan. Luckily, Mezzanine financing doesn't show up as a loan. Instead it appears as equity on the balance sheet, enabling future borrowers to think you aren’t servicing any loan.
You can choose to pay interest charges with cash, add them to the loan balance, or provide equity-like instruments to the lender.
In the event the business fails, mezzanine lenders won’t trouble you. At least, not until you’ve settled all traditional lenders you’re obliged to.
Cons of mezzanine financing
Mezzanine lending usually comes with hefty, double-digit interest rates. Most times, you’ll find interest rates in the region of 15%-20% or above.
You may not find a mezzanine lender for all of your business situations. In fact, most lenders only consider it for situations involving:
If you default on payment, you might lose a certain percentage (control) of your business.
Now that you’ve seen how they all compare, which do you think is best for you? Sleep on it and make a calculated decision. But be sure whatever decision you make is in the best interest of the business.
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DISCLAIMER: We hope whatever you find on this site is helpful, but be cautioned that it may not apply to your own situation, or be totally current at any given time. Idea Cafe Inc. and all of its current and past experts, sponsors, advertisers, agents, contractors and advisors disclaim all warranties with regard to anything found anywhere on this family of websites, quoted from, or sent from Idea Cafe. and its related sites, publications and companies. We also take no responsibility for comments published by others on these pages. TRADEMARKS: The following are Registered Trademarks or Servicemarks of DevStart, Inc.: Idea Cafe®, Online Coffee Break®, The Small Business Gathering Place®, Take out Info®, Biz Bar & Grill®, Complaint-O-Meter®, A Fun Approach to Serious Business, CyberSchmooz, and BizCafe.
DISCLAIMER: We hope whatever you find on this site is helpful, but be cautioned that it may not apply to your own situation, or be totally current at any given time. Idea Cafe Inc. and all of its current and past experts, sponsors, advertisers, agents, contractors and advisors disclaim all warranties with regard to anything found anywhere on this family of websites, quoted from, or sent from Idea Cafe. and its related sites, publications and companies. We also take no responsibility for comments published by others on these pages.
TRADEMARKS: The following are Registered Trademarks or Servicemarks of DevStart, Inc.: Idea Cafe®, Online Coffee Break®, The Small Business Gathering Place®, Take out Info®, Biz Bar & Grill®, Complaint-O-Meter®, A Fun Approach to Serious Business, CyberSchmooz, and BizCafe.