Mezzanine finance
Also known as: Mezz, Subordinated debt, Junior capital
Debt between the senior lenders and the equity. Paid last among lenders, first among owners — and the intercreditor agreement is the deal.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat actually happens?
When a buyout needs more money than the senior lenders will provide, and the buyer does not want to put in more equity, something has to fill the gap. Mezzanine is that filler.
It is a loan, but a loan that agrees to stand behind the main lenders. If things go wrong, the senior lenders are paid first and the mezzanine lender waits. If nothing is left, it gets nothing.
For accepting that, it is paid much more. Often part of the interest is not paid in cash at all — it is added to the amount owed, so the debt grows quietly while the company keeps its cash. And frequently the lender also gets a small slice of the equity, so that if the business does very well it shares in that too.
Which makes it an odd instrument: it behaves like debt when things go well and like equity when they do not. That is precisely where it sits.
- 1
Structuring2–5 wks
How much cash interest, how much rolled up, and what equity participation comes with it.
- 2
Intercreditor3–6 wks
The document that says what the mezzanine lender may and may not do if things go wrong — the real negotiation.
- 3
Funding1 day
Drawn alongside the senior debt, into the same structure.
- 4
Accrual3–6 yrs
Interest accrues, some in cash and some rolled into the principal, which grows.
- 5
Exitat sale
Repaid on a sale or a refinancing, with whatever equity participation was agreed.
Does the senior lender allow it — The senior lenders decides. Mezzanine exists only in the space the senior debt documents leave for it.
Is there value left — The exit price decides. Mezzanine sits just above the equity, so a mediocre exit is where it discovers whether it was debt or not.
Who is on the deal
| Who | Side | What they are actually for |
|---|---|---|
| The mezzanine lender | Buy side | Is paid last among the lenders and first among the owners, and prices accordingly. |
| The senior lenders | Neither | Decide, through the intercreditor agreement, what the mezzanine may do if anything goes wrong. |
| The sponsor | Sell side | Uses mezzanine to reach a price the senior market alone would not support. |
| The borrower | Sell side | Carries interest that partly rolls up, so the principal grows while nothing appears to happen. |
- Desk
- Leveraged Finance
- Ranking
- Behind senior debt, ahead of equity
- Interest
- Part in cash, part rolled into the principal
- Often includes
- An equity participation, small but real
- Key document
- The intercreditor agreement, not the loan
What decides whether it completes
Not how hard this is, and not a rating — there is deliberately no total. It says which of five blockers decides whether this transaction happens at all, in the same order on all 70 transaction types so they can be compared. This publication's own reading; see the notice below.
- Pricedecides it
- Financingmatters
- Approvalbarely applies
- Diligencebarely applies
- Executiondecides it
What decides it here. Mezzanine only exists in the space the senior documents leave for it, so the intercreditor agreement is the transaction. What the lender may do when things go wrong is negotiated at the start, and it is worth more than the coupon it is paid.
3 · IntermediateHow it runs in practice
The intercreditor agreement
The document that actually matters. It says:
- Payment blockage — when the senior lenders may stop the mezzanine being paid, and for how long.
- Standstill — how long the mezzanine must wait before it may take any enforcement action, even after a default.
- Release provisions — the senior lenders' right, on enforcement, to sell the business free of the mezzanine's claims.
- Turnover — an obligation to hand over anything received out of turn.
That third one is the sharpest. In many structures a senior lender enforcing security can sell the company and release the junior debt entirely, provided a fair value process is followed. The mezzanine's protection is that process, not its contract with the borrower.
Payment-in-kind interest
Interest that is added to the principal rather than paid. It preserves the borrower's cash, which is why it exists, and it compounds — a loan at a high rate accruing for five years can be a multiple of what was drawn. It is the clearest example on this desk of a cost that is invisible in the cash flow statement and enormous on the balance sheet.
The equity kicker
Warrants, or a small direct stake. It converts part of the return from contractual to contingent and aligns the lender with the outcome. It is also the feature that makes mezzanine expensive to the sponsor in the good case, which is part of why it fell out of favour when unitranche offered a single instrument instead.
Where it still appears
Where a structure needs a layer that senior lenders will not provide and the sponsor will not fund with equity: an aggressive purchase price, a business with volatile earnings, or a situation where the senior market has retreated. It is a market that expands and contracts with the appetite of the layers around it.
4 · AdvancedThe numbers & the documents
Why the return is asymmetric in an uncomfortable way
Mezzanine's upside is capped at its contracted rate plus a small equity share. Its downside, in a poor outcome, is a total loss — it sits just above the equity, and the equity is frequently already worthless before the mezzanine is impaired at all.
That is the shape of a written option: limited gain, substantial loss, a fee collected in the meantime. It is a perfectly legitimate position to hold, priced accordingly, and it explains why this asset class performs steadily for years and then does not.
The value break, seen from here
In a restructuring, whoever sits at the point where enterprise value runs out negotiates for the company; everybody below negotiates for option value. Mezzanine is very often exactly at or below that line — see restructuring and the debt-for-equity swap, where the layer that was mezzanine frequently becomes the new owner or receives nothing at all.
Second lien, and how it differs
A second lien loan shares the same security as the senior debt but ranks behind it. Mezzanine is typically unsecured and structurally junior. In a good outcome the distinction is academic; in an enforcement it is everything, because a second lien holder is a secured creditor with a voice and an unsecured junior lender frequently is not.
Reading a structure with a junior layer
- How long the standstill is, and what starts it.
- Whether the senior lenders can release the junior claims on an enforcement sale, and what fair value process applies.
- How much of the interest is cash and how much accrues, and what the accrued balance looks like at maturity.
- Whether the junior lender has any right to buy out the senior debt at par — an option that is worth a great deal in a distressed situation.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow people on the deal think about it
Now say it back
Close the page and give Mezzanine finance in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — name both sides and what each one is actually trying to get.
- What has to happen, in order — the three or four stages, not the whole timetable.
- Where the money comes from — cash, new shares, or borrowed; somebody has to fund it.
- What kills it — the ordinary way, not the dramatic one.
Where this transaction shows up elsewhere
- EasyLeveraged buyoutDealA company bought largely with borrowed money, secured on the company itself
- HardLevfinDeskHow a buyout is funded: the commitment, the flex, syndication, covenants and the exit that has to exist before the…