Mezzanine

The term “mezzanine” covers a range of financing solutions along the spectrum between debt and equity, with varying degrees of risk and return.

Broadly speaking, these quasi-debt and quasi-equity mezzanine products can offer financing that senior, secured lenders are unwilling to provide. Therefore, mezzanine finance is usually a solution in one or more of the following situations:

• Excess leverage. The most common role for mezzanine is providing leverage beyond the level that senior lenders are comfortable extending to fund a firm’s growth (whether that growth is through acquisitions or organic).
• Subordination. Mezzanine lenders are generally subordinated to senior lenders, either directly in the operating company (thus with a second lien on assets or first lien on shares, when applicable) or structurally subordinated (such as by lending to a holding company or by virtue of longer maturities).
• Take-out financing. These are situations where equity sponsors need capital to buy out a partner or to take out funds for themselves.
• Sponsor financing. In these situations, equity sponsors or management need funding to acquire or consolidate equity (as in a management buy-out);
• Refinancing. Here, mezzanine is used to refinance maturing or poorly structured or short-term debt. This is often used to provide permanent working capital for poorly funded companies, particularly in environments with high interest rates.
• Absence of asset coverage. Asset-light companies, such as service companies, often have trouble securing senior debt financing, which creates opportunities for mezzanine lenders.
• Equity substitute. These are situations in which the company needs equity but is unwilling to suffer the dilution and shared governance associated with normal private equity investments.
• Higher sovereign risk. Solid companies in challenging countries offer the possibility of negotiating more senior/secured structures with mezzanine-like pricing, including elements such as equity kickers.