Mezzanine Financing

by

Stefanie Welz

List of Contents

1 INTRODUCTION 1

1.1 Executive Summary 1
1.2 Scope of work 2

2 PROBLEM AND RESEARCH 3

2.1 Problem definition 3
2.2 Relevance and motivation 3
2.3 Methodology 4

3 RELEVANT THEORIES 5

3.1 Principal Agent Theory 5
3.2 Transaction Cost Theory 7
3.3 Property Rights Theory 8

4 FINANCING VIA MEZZANINE 9

4.1 Definition 9
4.2 Characteristics 10

4.2.1 Mixed form 10
4.2.2 Debt capital related components 12
4.2.3 Equity related components 13

4.3 Application of Mezzanine capital 15

5 BENEFITS OF MEZZANINE CAPITAL 16

6 CONCLUSION 18

BIBLIOGRAPHY VI

APPENDIX X

ITM CHECKLIST X

1 Introduction

1.1 Executive summary

The term Mezzanine resounded throughout the land. Mezzanine financing instruments, which represent a mixed form between equity and debt capital, are considered as the financing alternative particularly to medium-size enterprises, whose financial situation substantially worsened due to the difficult overall economic situation in the last years. Particular with regard to Basel II and the more restrictive granting of loans lead to an intensification of the situation due to the fact that German medium-size companies traditionally have a little equity ratio which is however relevant for their rating and thus make it difficult to revert to the financing practice of the house bank so far. In order to improve the equity situation, Mezzanine financing instruments can be used, which are at least economically assigned to equity depending on the definition during the rating process. This assignment however primarily addresses the issue of economic aspects of the financing instrument which have relevant influence on the representation of the balance sheet.

1.2 Scope of work

The assignment Mezzanine financing starts with the introduction which includes the executive summary and the scope of work that is realized in here. The second chapter deals with a detailed definition of the problem that causes the relevance of this assignment, the determination of the objectives as well as the methodology that describes the assignment’s structured procedure. Chapter three is focused on the underlying theories of Mezzanine financing. At this juncture in particular the principal agent, the transaction cost and the property rights theory according to Mezzanine financing are being analyzed.
Chapter four is about basics, typical characteristics and the application areas of Mezzanine capital whereas the chapter five deals with the benefits of Mezzanine capital. Finally, the results of this assignment are summarized; especially whether the set objectives are reached as well as critical comments about the assignment are given in the last chapter.

2 Problem and Research

2.1 Problem definition

The financing situation for medium-size companies substantially changed in the past years. For many companies the bank loan so far formed the emphasis for the covering of capital requirement. This loan capital nevertheless represented the most favourable financing form. For medium-size businesses this source of finance became increasingly problematic. The regulations of the Baseler committee for state supervision of banks, generally known as Basel II, contain a stronger risk adequate loan conditioning. Despite the situation on the debt market, the provision of equity also became more difficult. The possibility of equity provision via the stock exchange appears unrealistic with regard to the capital market surroundings which show no acceptance for new IPO’s. For the admission of Private Equity, the claimed requirements often can not be fulfilled. Due to the fact that many medium-size companies could only limited use self-financing instruments e.g. the retention of earnings mainly because of depending market conditions, alternative financing instruments come to the fore. An alternative and flexible financing form is the hybrid Mezzanine financing. With Mezzanine capital companies are provided with financing instruments which appear suitable to meet the individual interests. In practice however, they are used only rarely.

2.2 Relevance and motivation

According to arising difficulties in raising capital, new financing forms are essential requirements from managerial point of view. This change requires a stronger orientation of business enterprises towards optimized financial structures in order to create a lasting added value for the enterprise. In order to meet these requirements, the primary objective of this assignment is to explain Mezzanine capital as a financing form. The interest of involved parties regarding the company’s financing are analyzed. Furthermore, an examination was done whether Mezzanine capital is suitable for solving financing problems of medium-size companies.

2.3 Methodology

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