How mezzanine finance can help ambitious SMEs to grow

Darren Hart, head of growth capital at Santander UK, looks at how mezzanine finance can fit nicely between private equity and angel investments for mid-market businesses.

SMEs are vital to the health of the UK economy and fast-growth businesses, in particular, play an important role in driving growth and creating new jobs.

However, it’s these businesses, the ones with the potential to grow rapidly, that often find it the most difficult to obtain the funding they require.

Business owners need finance in order to invest but they want to retain control of their business and not give up valuable equity. It’s a difficult situation for any ambitious entrepreneur.

For companies with annual turnover of between £500,000 and £10 million, the finance options are particularly limited. Private equity investors – who are very much in the business of providing growth finance – are usually only interested in larger companies, while business angel investors are more active in start-ups. Furthermore, conventional bank lending is often not available for projects that could be classified as speculative.

That’s where mezzanine finance comes in. Mezzanine finance is a fairly well-known type of funding, which sits between traditional bank debt and equity. However, it is a type of finance not widely utilised by British banks due to its relatively high risk factor.

Yet it is exactly what many SMEs need. They crave high-speed growth and an ability to adapt, whilst also requiring a similarly flexible lending option, as shown by Vocality, a satellite communications business.

Having reached a pivotal point in its development, Vocality needed funds for research and development in order to create products to generate future growth. However, without the extra value the new products would bring to the business, Vocality was struggling to raise those funds. This catch-22 scenario is experienced by entrepreneurs and small businesses country-wide, and is the conundrum that mezzanine financing aims to solve as it is based on cash flows and future potential, rather than existing assets. For Vocality, which had a strong business plan and a desire to innovate, mezzanine financing enabled it to fund the research and development it needed to develop its product pipeline.

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This growth is where the widespread economic benefits of such a scheme come from. Expanding SMEs are at the forefront of job creation and need support in this respect if the country is to recover its GDP growth. Santander’s Growth Capital mezzanine fund invested in four businesses in 2012, its first year, and created 230 jobs in the process.

If just four companies can create 230 jobs, imagine what could happen if SMEs had widespread access to this type of investment finance. There are 165,000 businesses in the UK with a turnover of between £500,000 and £10 million, those most in need of growth funding. Even if only 5 per cent of these businesses have a strong enough growth strategy to be eligible for funding (a conservative estimate) that would equate to over 450,000 jobs created.

Mezzanine financing can be a very effective tool in aiding sales development and creating jobs, but a common question is how it impacts the internal structure of a business? This is the major issue between SMEs and equity investors.

Small businesses typically maintain a start-up attitude, with protective founders still firmly in the driving seat, whilst equity investment involves part ownership by those investors. This makes the decision between gaining funding and giving up a slice of the business very tough. Whilst mezzanine financing does require a bank to have a keen understanding of business plans, strategies and finances, the bank takes no control. This will come as a relief to those who have little or no interest in ceding ownership of something that has required years of time, money, sweat and passion and is just beginning to blossom.

The UK is full of great entrepreneurs building great businesses and the UK economy is dependent on their growth and productivity. Mezzanine finance is an innovative finance solution and we believe that, combined with a comprehensive support programme, it could be the key which enables them to unlock their potential.

Hunter Ruthven

Hunter Ruthven

Hunter was the Editor for from 2012 to 2014, before moving on to Caspian Media Ltd to be Editor of Real Business.

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Mezzanine funding