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Mezzanine Financing

About Mezzanine Financing

Mezzanine financing is a method that typically involves a greater degree of investment risk than the senior financing employed by financial institutions. (“Mezzanine” literally refers to the partial storey between two main stories of a building.)
Senior financing (senior loans, etc.) involves relatively low risk. In Japan, most corporate bond issues and funds provided by financial institutions are senior financing. By comparison, mezzanine financing is lower in the repayment hierarchy, so risk is higher than for senior financing. In markets such as the United States, which have a broad range of investors, mezzanine financing plays an important role in diversifying the types of funding that are provided. As mezzanine financing is riskier than senior financing, it bears a correspondingly higher interest premium, making it an economically rational choice of investment funds.
Depending on financing needs and capital policies, various types of mezzanine financing can be introduced and set to have diverse characteristics corresponding to both equity and debt. Financial leverage can be increased for individual businesses, thereby reducing the required amount of equity. For sponsors, this increase in leverage corresponds to higher investment return and allows them to apply available funds to other projects.

Types of mezzanine financing

  • Subordinated loans, subordinate corporate bonds
  • Preferred shares, classified shares
  • Hybrid securities, hybrid loans, etc.

In Consideration of Mezzanine Financing

The following points should be kept in mind when considering mezzanine financing as a method of financial restructuring.

  • Allows room for the development of aggressive operating strategies flexible financial strategies while meeting target capital ratios
  • Policies should be formulated to achieve growth commensurate with the cost of mezzanine financing
  • Stabilizes the financial base in preparation for future risk
  • Introducing mezzanine financing can raise creditworthiness and increase funding independence

Benefits of Mezzanine Financing

Some of the general benefits of employing mezzanine financing are summarized below.

  • Provides funding that may be difficult to obtaining through senior loans
  • Avoids diluting the voting rights of existing shareholders
  • Economically, also avoids or reduces the dilution of common shareholders
  • Redemption schedules can be set to be relatively rigid or flexible (to postpone or accelerate redemption)

Preferred Shares and Subordinated Loans

About Preferred Shares

  • Precede common shares in the repayment hierarchy, after paying dividends and dividing residual assets
  • In general, do not have voting rights but instead are set to have a relatively high dividend payout ratio
  • May come with an equity kicker (stock acquisition rights, conversion rights to common shares)
Benefits
  • As ratios of voting rights do not change, can be used to increase capital
  • Makes financial balance improvements tangible in the financial statements (in the case of shares, marked as “shares”)
  • May come with an equity kicker (stock acquisition rights, conversion rights to common shares)
Considerations
  • Issuance typically requires changes to the Articles of Incorporation
  • Dividends are post-tax, so no tax-reduction effects
  • There is no way to force redemption depending on income or losses during the limitation period

About Subordinated Loans

  • Subordinated debt has a lower repayment ranking than other debt, and the dividend payout hierarchy is lower in the event of liquidation
  • Various types of subordination exist, ranging from subordination only of time period to the subordination of repayment order or other factors
  • May come with an equity kicker (stock acquisition rights, conversion rights to common shares)
Benefits
  • For the company, simpler borrowing procedures compared with preferred shares
  • Different from preferred shares, has tax reduction effect
Considerations
  • Contractually complex (according to bondholder agreements, adjustments with other bondholders possible)
  • Financial balance improvements more ambiguous in the financial statements than for preferred shares (formally listed as “borrowings”)

DBJ and Mezzanine Financing

For buyouts sponsored by funds and other financial investors, a substantial need for mezzanine financing exists. This type of financing can be used to enhance capital without altering the structure of voting rights. Furthermore, mezzanine financing can be employed for purposes of financial restructuring, in accordance with operating strategies.
DBJ responds to individual clients' business restructuring, financial restructuring or capital restructuring needs from a long-term viewpoint, DBJ offers mezzanine financing as one of its tailor-made financial solutions.

Case Study

NobelPharma Co., Ltd.

We identified NobelPharma's research and development capability and growth potential, and responded to its need for diversification in funding sources and better credit with an offering of stock with a redemption premium.

Isuzu Motors Ltd.

We formed the Isuzu Motors Fund. The fund's objectives are to provide medium- to long-term term support for Isuzu's organization, and to increase both its growth and its investor value.

UDS Mezzanine Fund

Mezzanine financing consists primarily of preferred stock and subordinated loans. While a need exists for such financing with respect to enterprise business reorganization, the number of providers of capital in such circumstances is limited. We have assembled this fund to conduct corporate mezzanine funding and make a commitment to building the mezzanine financing market.

USJ Co., Ltd.

In this case, shoring up the company's finances through a preferred stock issue, we proposed a refinancing solution that was instrumental in enabling USJ to list its shares. The outcome was positive for the company and the myriad people who are associated with the park's operation.

Hoyo no Yado Himi

DBJ formulated an investment and loan scheme using project finance procedures and provided the funds necessary for Hoyo no Yado Himi to purchase the facilities it required and to ensure continuity of business.

JR Sapporo Hospital

DBJ acted as co-arranger in constructing a stable scheme under which local area financial institutions established senior loans and DBJ executed a mezzanine loan.

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