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Mezzanine capital is rapidly emerging as an attractive source of capital for mid-size corporates. This recent growth is driven by several new Non Banking Financial Companies (NBFCs) and funds that have started offering mezzanine capital products to Small and Medium Enterprises, in search of higher yields. This funding option, typically invested in the form of preference shares, convertible debentures or debt with warrants, is also gaining increasing acceptance among the SME entrepreneurs because of the flexibility that it offers.
FLEXIBLE TERMS
Mezzanine capital typically has characteristics of both debt and equity, combined to provide significant flexibility to the company, though at a relatively higher cost of funds than debt. The funds raised can be used for a wide range of end-uses, some of which may even be prohibited through bank funding — such as financing an acquisition, purchase of land, creating intangible assets like brands, etc. The repayment terms are also typically flexible, with requisite moratorium and ‘pay when able' features, which are particularly useful for projects with uncertain timing of cash flows. The typical cost of mezzanine capital could be in the range of 18 per cent – 20 per cent, payable through a combination of periodic coupon, redemption premium, as well as warrants / profit sharing.
MINIMAL EQUITY DILUTION
Mezzanine capital funding typically involves minimal or no dilution of equity stake, provided the future cash flows are sufficient to redeem it. This non-dilutive nature makes it an attractive proposition for companies with healthy growth prospects, as formal equity fund raising — such as through Private Equity or Initial Public Offer — can be deferred by a few years to divest at significantly higher valuation.
SECTORS PREFERRED BY INVESTORS
Mezzanine capital investors look to invest in companies across a wide range of sectors, including manufacturing, real estate, infrastructure, and service sector. Companies with revenues of Rs 100 crore or more, with good credit standing, established performance record, and good growth prospects, are the most sought after by mezzanine capital investors.
In well-developed financial markets, investors with a wide range of risk appetites operate in different segments of the market, starting from the low-risk Government treasury bills, to high-risk distressed assets and structured products. Mezzanine capital is a well-developed segment in the medium-high-risk category, with return expectations slightly higher than debt. The development of such a segment in India is good in the long run, both for the companies as well as for the financial markets.
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