Mezzanine Finance

The power of mezzanine finance: A comprehensive guide for South African entrepreneurs

Mezzanine finance is a hybrid form of financing that combines elements of debt and equity financing. It’s commonly used by businesses to raise capital for various purposes, such as expansion, acquisitions, or refinancing existing debt. With mezzanine finance, the lender provides a loan that is typically unsecured and has a higher interest rate than traditional debt financing.

In exchange for the loan, the lender also receives an equity stake in the business. It’s often used by businesses that are not yet ready for an initial public offering (IPO) or traditional bank financing but are looking for a flexible and customisable form of financing to support their growth.

Bridging the funding gap: How mezzanine finance is empowering small businesses in South Africa

Mezzanine finance is a crucial part of South Africa's economic development. It serves as a flexible financing option that can bridge the funding gap for companies that are unable to secure traditional debt or equity financing.

This is especially important for small and medium-sized enterprises (SMEs) that may not have access to other forms of funding. Additionally, it can support growth initiatives, such as expansion into new markets, the development of new products or services, or the acquisition of other businesses, helping SMEs to scale up and become more competitive.

Mezzanine finance can promote black economic empowerment initiatives, which are a key priority for the South African government. By providing funding to black-owned businesses, it can promote greater economic inclusion and reduce inequality. Lastly, it can help create and sustain jobs by enabling SMEs to grow and expand. Overall, it’s an essential financing option for South African businesses, especially SMEs, and can play a significant role in driving economic growth, promoting transformation, and creating jobs.

Unlocking the power of mezzanine finance: Discovering the different types of financing available

Mezzanine finance offers a flexible financing option for businesses that may not have access to traditional forms of funding. In this section, we will explore three popular types of mezzanine finance: debt with equity kickers, convertible debt, and preferred equity. Each of these options has its own unique features and benefits, so read on to find out which one might be the best fit for your business.

1. Debt with equity kickers: This type of mezzanine financing is like a superhero's cape, giving a boost to businesses looking to take their operations to new heights. It's essentially a loan that includes an equity kicker, which means that the lender has the option to convert the debt into equity, or ownership in the company, at a later date. Think of it like a two-for-one deal, providing companies with the financial resources they need now, with the potential for future growth.
2. Convertible debt: If you're looking for a mezzanine financing option that's as flexible as a yoga instructor, then convertible debt is the perfect choice. This type of financing is a loan that can be converted into equity at a later date. The beauty of this option is that it gives businesses the ability to raise capital without sacrificing ownership or control.
3. Preferred equity: Last but not least, we have preferred equity, the mezzanine financing option that's like having your cake and eating it too. It's a cross between debt and equity, giving lenders an ownership stake in the company, but without the same voting rights as common shareholders. This means that businesses can raise capital without sacrificing control, and lenders can enjoy the benefits of ownership without the same level of risk.

Now that you know about the different types of mezzanine finance available, it's time to decide which one is the best fit for your business. Remember, each option has its own unique benefits and drawbacks, so be sure to do your research before making a decision.

Advantages and disadvantages of mezzanine finance

Mezzanine finance has several advantages over traditional financing options, making it an attractive option for businesses in South Africa, let’s take a look at some of these.

• Increased flexibility: Mezzanine finance offers more flexibility than traditional debt or equity financing. It allows for customized financing solutions that meet the unique needs of businesses, without the restrictive covenants and collateral requirements of traditional debt financing.
• Lower cost of capital: Mezzanine financing can be less expensive than equity financing, as it typically comes with a lower interest rate than other types of debt. This makes it an attractive option for companies looking to raise capital without diluting their ownership.
• Potentially higher returns for investors: Mezzanine finance can offer potentially higher returns for investors than traditional debt financing, as it comes with a higher interest rate and the potential for equity upside.

While mezzanine finance can offer several advantages, it also has its drawbacks, let’s find out what these are.

• Higher risk for investors: Mezzanine finance is considered a higher-risk investment than traditional debt financing, as it sits higher up the capital structure and typically comes with fewer covenants. This means that in the event of a default, mezzanine investors are less likely to recover their investment than traditional debt investors.
• Less control for entrepreneurs: Mezzanine finance typically comes with fewer covenants than traditional debt financing, but it still requires some level of control over the company's operations. This can be a disadvantage for entrepreneurs who want to maintain full control over their business.
• More complex than traditional financing options: Mezzanine finance can be more complex than traditional debt or equity financing options. It typically requires specialised knowledge and expertise to structure the financing and manage the investment. As a result, it may not be the best option for all businesses.

Mezzanine finance can be a great financing option for businesses looking to expand or fund a new project. However, securing this type of financing can be a complex process. It requires careful planning and negotiation. Make sure you have a solid business plan and financial projections, understand the terms of the financing, and negotiate with multiple providers to find the best terms for your business.

Is your company eligible for mezzanine finance?

• Strong financials: The business seeking mezzanine finance should have a proven track record of financial stability and growth, with consistent revenues and profits.
• Investment size: Mezzanine finance providers typically have a minimum and maximum investment size, and the business seeking funding should fall within that range.
• Equity stake: Mezzanine finance providers usually require an equity stake in the business as part of the funding arrangement.
• Mezzanine finance use: The intended use of mezzanine finance should be clearly defined and in line with the provider's investment criteria.
• Exit strategy: The business should have a clear and viable exit strategy, such as an initial public offering (IPO), strategic sale, or management buyout.
• Security: Mezzanine finance providers often require some form of security, such as assets or personal guarantees, to mitigate their risk.
  Legal compliance: The business should be compliant with all relevant laws and regulations, including tax and labour laws.

Steps to secure mezzanine finance in South Africa

1. Before approaching mezzanine finance providers, you should determine how much funding your business needs. This will help you identify the best financing options and ensure you are not over- or under-financed.
2. Once you have determined your financing needs, you can begin researching potential mezzanine finance providers. Consider factors such as their track record, experience in your industry, and the terms they offer.
3. Mezzanine finance providers will want to see a detailed business plan and financial projections before considering your application. Make sure your business plan outlines your goals, strategy, and financial projections. You should also include a clear repayment plan for the mezzanine finance.
4. Mezzanine finance typically comes with high-interest rates and may also require equity ownership in your company. Make sure you fully understand the terms of the financing before accepting any offers.
5. When negotiating with mezzanine finance providers, be prepared to provide detailed information about your business and financial projections. Consider working with a financial advisor or lawyer to help you negotiate the best terms.

8 mezzanine finance providers in South Africa

We have included profiles for 8 South African lenders that offer mezzanine finance for you to consider and we’ve summarised them below. Full profiles for each lender are available if you scroll to the bottom of this guide.

Provider #1: Ethos

Ethos, an African investment manager, has merged with global asset management firm The Rohatyn Group (TRG) to unlock growth opportunities across Africa's private markets, real assets, and public markets. Ethos, founded in 1984, has transformed into a multi-fund platform with a strong presence in Africa since 2016. TRG, established in 2002, operates in 18 countries worldwide with a focus on emerging markets. Ethos Mezzanine Partners 3, an Ethos subsidiary, provides mezzanine financing solutions to mid-market companies in East and Southern Africa and aims to bridge funding gaps for mid-market businesses. It invests in companies with strong growth potential in consumer goods, financial services, and telecommunications sectors.

Provider #2: Future Growth

An asset management company with assets under management of around R192.3 billion. The company offers investment funds that cater to fixed-interest and developmental investments and works with strategic partners to ensure positive impacts on society and the environment. Future Growth is committed to transformation, responsible investing, and social responsibility. They also provide debt and equity financing, including mezzanine finance, to businesses in various sectors, including agriculture, renewable energy, housing, infrastructure, and commercial property. They seek long-term partnerships, and its investment team has expertise across various asset classes to provide tailored financing solutions.

Provider #3: Norsad Capital

Norsad Capital is a Botswana-based financial institution that provides private credit options to medium-sized companies in Africa, promoting growth and development on the continent. It offers tailor-made debt financing solutions to African businesses that can produce positive social and environmental impacts, alongside financial returns. Its services include senior debt, stretch senior, unitranche, second lien, and mezzanine finance, all tailored to each client's capital structure and business requirements. Norsad Capital's investment process is rigorous and aimed at finding investment partners that align with its goal of improving Africa. The investment assessment process involves pipeline sourcing, deal identification, credit committee appraisal, due diligence, and final approval by a board of members with various backgrounds.

Provider #4: RMB

A company that attributes its competitive advantage to its capacity to deliver specialised skills. The division that deals with investment banking provides a different funding strategy called principal investments, including mezzanine finance services. The principal investments plan allows RMB to design, consult on, and finance custom mezzanine transactions in real estate, renewable energy, infrastructure, BEE, mining, and telecom sectors without any asset class restriction. The minimum funding requirement for RMB's mezzanine finance offering is R75 million, and clients must demonstrate their clear plan for achieving strategic objectives and long-term growth.

Provider #5: SAAD

SAAD Investment Holdings, a division of the Tree of Life group, focuses on purchasing, establishing, and growing companies in various sectors with a long-term perspective. The company identifies as active investors who support the businesses they’ve invested in through capital injection, strategic guidance, and connections to business networks. SAAD provides a combination of equity and debt to fund the continued growth of their investments, including Tafelberg Furnishers, Agventure, and Computer Mania Group. The company's mezzanine finance offers select businesses with proven business concepts and real growth opportunities an attractive option for raising capital without diluting equity or losing control of their company. SAAD Investment Holdings is owned by the Tree of Life Foundation, which aims to support qualifying charities in South Africa and Africa through an endowment fund and a donor-advised fund platform.

Provider #6: Spartan

Spartan is a financial services provider that has been supporting small and medium-sized enterprises (SMEs) in South Africa since 1981. The company offers mezzanine finance, which provides long-term financing to established SMEs and is more flexible than traditional bank financing. Spartan has integrated technology into its financing solutions, making the application process quick and straightforward. The eligibility criteria for mezzanine finance include a minimum operational period of three years and a minimum annual turnover of R10M.

Provider #7: Tamela

Is an investment, fund management, and corporate finance advisory company founded in 2008 by Sydney Mhlarhi and Vusi Mahlangu. Tamela's team has a track record of success and its values are built on trust, partnership, and professionalism. The company's diverse backgrounds and experience enable them to provide a broad range of investment and corporate finance advisory services. Tamela's primary focus is on privately held businesses that have competent management teams. Its flexible investment mandate allows it to structure investments to meet the needs of its investee companies. Tamela offers mezzanine finance, mergers and acquisitions transaction support, capital-raising services, and expert guidance on Black Economic Empowerment (BEE) transactions and Debt Capital Markets (DCM). To be eligible for funding, businesses must have a strong management team with relevant industry experience, a clear strategy for growth and profitability, and a track record of success in their industry.

Provider #8: Vantage Capital

Vantage Capital is a leading African investment firm that focuses on building mutually beneficial long-term relationships with stakeholders. The company offers mezzanine finance, a flexible financing instrument that bridges the gap in funding where traditional banks are reluctant to lend. Mezzanine debt allows businesses to make acquisitions and secure funding that may not be available through traditional lending sources. Vantage Capital's mezzanine funding product is suitable for business expansion, acquisitions, share acquisitions, replacement capital, existing debt refinancing, and alternative medium-term funding. The tenor is between four and six years, and the pricing is an interest rate and equity kicker that varies depending on the company's risk and the country in question.

So, what now?

Mezzanine finance is an essential financing option for businesses in South Africa, especially for small and medium-sized enterprises that may not have access to traditional debt or equity financing. It’s a flexible financing option that can bridge the funding gap and support growth initiatives, promote black economic empowerment initiatives, and help create and sustain jobs.

It comes in various forms, including debt with equity kickers, convertible debt, and preferred equity, each with its own unique features and benefits. While it offers several advantages, including increased flexibility, a lower cost of capital, and potentially higher returns for investors, it also has its drawbacks, such as higher risk for investors, less control for entrepreneurs, and greater complexity than traditional financing options.

You should carefully evaluate your options and do your research before choosing a mezzanine financing option. We recommend checking out the profiles of the mezzanine finance providers below to find one that will best suit your company.

Your top 10 FAQs about mezzanine finance answer

What is mezzanine finance?

Mezzanine finance is a hybrid form of financing that combines elements of both debt and equity financing.

How is mezzanine finance different from traditional debt or equity financing?

Mezzanine finance is typically subordinated to senior debt and has a higher interest rate than traditional debt financing, but offers more flexibility than equity financing.

What types of companies are good candidates for mezzanine finance?

Companies that are cash flow positive and have a clear path to growth are good candidates for mezzanine finance.

How do I apply for mezzanine finance?

You would typically apply for mezzanine finance through a financial institution or private equity firm that specializes in mezzanine finance.

What is the typical loan size for mezzanine finance?

Mezzanine finance loan sizes typically range from R10 million to R100 million.

What is the typical repayment period for mezzanine finance?

The typical repayment period for mezzanine finance is between 5 to 7 years.

What is the interest rate for mezzanine finance?

The interest rate for mezzanine finance is typically between 12% to 20%, depending on the risk profile of the investment.

What are the fees associated with mezzanine finance?

Fees for mezzanine finance typically include an arrangement fee, commitment fee, and success fee, among others.

What are the risks associated with mezzanine finance?

The main risk associated with mezzanine finance is the potential for default, which can result in the loss of the investment.

What are the benefits of mezzanine finance?

The benefits of mezzanine finance include lower dilution of ownership than equity financing, more flexibility than traditional debt financing, and the ability to leverage existing cash flow.