Finance term
Mezzanine Debt
Also known as: mezz debt, mezzanine financing, subordinated mezzanine, mezzanine loan
Definition
Mezzanine debt is a hybrid financing instrument that sits between senior secured debt and equity in a company's capital structure — typically unsecured, bearing higher interest rates (12-20%+ PIK or cash), and frequently including warrant kickers or equity co-investment rights.
Detailed explanation
Mezzanine debt fills the gap between what senior lenders will advance and the equity a sponsor brings to an acquisition or growth transaction. It is subordinated to all senior debt but senior to preferred and common equity. Because mezz lenders take more risk than senior lenders (no collateral, last in line before equity), they demand higher returns — typically through a combination of cash interest, PIK (payment-in-kind) interest, and equity participation via warrants or equity co-investments.
Structure: Mezzanine debt is typically issued as a term loan or subordinated notes with 5-7 year maturities. The 'all-in yield' target is usually 15-20% for middle-market deals. This blends: (1) cash interest (12-14%), typically at a fixed rate or SOFR+; (2) PIK interest (accrued and added to principal rather than paid currently — preserving borrower cash flow); (3) equity kicker — warrants to purchase equity at a nominal price, or direct equity co-investment alongside the deal's private equity sponsor.
Mezzanine providers include specialized mezzanine funds, business development companies (BDCs), insurance companies, and some banks. The SEC regulates BDCs under the Investment Company Act of 1940. Mezzanine lending is typically exempt from FDIC-insured bank leveraged lending guidance (OCC/Fed/FDIC 2013 Leveraged Lending Guidance) when provided by non-bank funds.
For growing businesses (outside PE buyout context), 'mezz' financing can fill capital gaps between senior SBA/bank loans and owner equity — enabling growth without full equity dilution. However, high all-in cost (15-20%+) means mezzanine is only appropriate when asset returns clearly exceed financing cost.
◈ Worked example
- Private equity buyout: $50M company acquired with $25M senior bank loan, $15M mezz debt (14% cash + 2% PIK + warrants for 5% equity), and $10M equity from sponsor. Mezz cost of capital ~18% all-in.
- Growth financing: An established manufacturer needs $5M to expand capacity beyond what the senior bank will lend. A mezzanine fund provides $5M at 13% PIK-toggle + 2% equity warrant — cheaper than equity dilution if the expansion generates 25%+ ROIC.
- Mezzanine in CMBS: In real estate, mezzanine debt sits behind the senior mortgage but ahead of the equity. A $20M office building financed with $13M senior mortgage, $4M mezzanine, and $3M equity — the mezzanine lender holds a pledge of equity interests (not a lien on the real estate) in the property-owning entity.
Common questions
The most-asked questions about Mezzanine Debt — answered straightforwardly.
What is a warrant kicker in mezzanine financing? +
A warrant kicker gives the mezzanine lender the right to purchase equity in the company at a nominal price (often $0.01 per share or a pre-agreed nominal amount), exercisable at or after loan maturity. The warrant compensates the lender for the subordinated risk position and allows participation in upside if the company is sold at a premium. Warrants typically represent 5-15% equity on a fully diluted basis.
How is mezzanine debt different from subordinated debt? +
All mezzanine debt is subordinated debt, but not all subordinated debt is mezzanine. Subordinated debt is any debt with lower priority than senior debt. Mezzanine specifically refers to the hybrid layer with equity features (warrants, co-investment rights, PIK toggle). 'Subordinated debt' without equity features is sometimes called 'second lien' or 'junior term loan.'
Further reading
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