In their efforts to grow and succeed, many companies eventually reach the edge of a precipice. Across the divide lies a big step forward — perhaps the acquisition of a competitor or the purchase of a new property — but, financially, there’s no way across. The money is just not there.

One way to bridge that divide is with a mezzanine loan. These instruments (also known as junior liens and second liens) can bridge financing shortfalls — so long as you meet certain qualifications and can accept possible risks.

Debt/equity hybrid

Mezzanine financing works by layering a junior loan on top of a senior (or primary) loan. It combines aspects of senior secured debt from a bank and equity obtained from direct investors. Sources of mezzanine financing can include private equity groups, mutual funds, insurance companies and buyout firms.

We live and work in an era of big data. Banks are active participants, keeping a keen eye on metrics that help them accurately estimate risk of default.

As you look for a loan, try to find out how each bank will evaluate your default probability. Many do so using spreadsheets that track multiple financial ratios. When one of these key ratios goes askew, a red flag goes up on their end — and the loan may be denied.

Common metrics

To avoid getting “ratio’d” in this manner, business owners should familiarize themselves with some of the more common metrics that banks use to gauge creditworthiness.

The American Rescue Plan Act (ARPA), signed into law in early March, aims at offering widespread financial relief to individuals and employers adversely affected by the COVID-19 pandemic. The law specifically targets small businesses in many of its provisions.

If you own a small company, you may want to explore funding via the Small Business Administration’s (SBA’s) Economic Injury Disaster Loan (EIDL) program. And if you happen to own a restaurant or similar enterprise, the ARPA offers a special type of grant just for you.

EIDL advances

Under the ARPA, eligible small businesses may receive targeted EIDL advances from the SBA. Amounts received as targeted EIDL advances are excluded from the gross income of the person who receives the funds. The law stipulates that no deduction or basis increase will be denied, and no tax attribute will be reduced, because of the ARPA’s gross income exclusion.

Congress recently passed, and President Trump signed, a new law providing additional relief for businesses and individuals during the COVID-19 pandemic. One item of interest for small business owners in the Consolidated Appropriations Act (CAA) is the opportunity to take out a second loan under the Paycheck Protection Program (PPP).

The basics

The CAA permits certain smaller businesses who received a PPP loan to take out a “PPP Second Draw Loan” of up to $2 million. To qualify, you must:

• Employ no more than 300 employees per physical location,
• Have used or will use the full amount of your first PPP loan, and
• Demonstrate at least a 25% reduction in gross receipts in the first, second or third quarter of 2020 relative to the same 2019 quarter. Applications submitted on or after Jan. 1, 2021, are eligible to use gross receipts from the fourth quarter of 2020.

Commercial loans, particularly small business loans, have been in the news over the past year or so. The federal government’s Paycheck Protection Program has been helpful to many companies, though fraught with administrative challenges.

As your business pushes forward, you may find yourself in need of cash in the months ahead. If so, more traditional commercial loan options are still out there. Before you apply, however, think like a lender to be as prepared as possible and know for sure that the loan is a good idea.