Mezzanine financing sits between senior debt and equity in a company’s capital structure, offering more capital than a bank will provide in exchange for higher returns and, in some cases, an equity participation right.
When a business needs more capital than its senior lender will advance but does not want to dilute equity, mezzanine financing fills the gap. It is structurally subordinated to senior debt, meaning the senior lender is repaid first in a default, which is why it commands a higher interest rate, often in the range of 12 to 20 percent, sometimes combined with warrants or equity kickers that give the lender a share of the upside.
Mezzanine financing is typically relevant in two scenarios: growth capital for businesses that have maximized their senior debt capacity and need additional funding for an acquisition or expansion, and leveraged buyouts, transactions where a business is acquired using a combination of debt and equity, where the structure requires a layer of capital between bank debt and the equity contributed by the buyer. It is expensive relative to bank debt but considerably cheaper in terms of dilution than issuing equity at an early or transitional stage.
See also: Subordinated Debt · Business Development Bank of Canada (BDC) · Equity RolloverMezzanine financing adds complexity to the capital structure that requires careful modelling. See how Wefinx approaches Virtual CFO services.