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Mezzanine Debt Structures

Mezzanine debt is a hybrid of debt and equity that provides capital to mid-market companies. It carries higher risk than senior debt with interest payments typically between 10-14% plus an equity kicker. Mezzanine financing allows companies to reduce their cost of capital while providing lenders potential equity upside. The debt is usually medium-term between 5-7 years and subordinated to senior debt. Recovery in default ranges from 20-30% of the amount owed.

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353 views2 pages

Mezzanine Debt Structures

Mezzanine debt is a hybrid of debt and equity that provides capital to mid-market companies. It carries higher risk than senior debt with interest payments typically between 10-14% plus an equity kicker. Mezzanine financing allows companies to reduce their cost of capital while providing lenders potential equity upside. The debt is usually medium-term between 5-7 years and subordinated to senior debt. Recovery in default ranges from 20-30% of the amount owed.

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JavierMuñozCanessa
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Mezzanine Debt

Mezzanine Debt Structures

Mezzanine debt becomes equity-like when an equity kicker is attached to the debt, which
generally comes as an equity warrant. A warrant is a call option issued by a corporation
on its own stock. The number of warrants included in the equity kickers is inversely
proportional to the coupon rate.

Mezzanine financing is an appropriate financing source for companies that have a reliable
cash flow who want to reduce their cost of capital.

The mezzanine piece can be structured as debt or equity, depending on how much power
the mezzanine issuer wants to obtain.

Typically, the total return sought by investors in mezzanine financing is in the range of
15% to 20%. The largest piece of the total return comes from the coupon rate (10% -
14%) and the remainder from the equity kicker upside.

The typical exit strategy occurs through a debt refinancing, an IPO or an acquisition.

Generally, it occurs in amounts below $400 million. In other words, it is used by middle-
market companies.

Mezzanine financing is highly negotiated and can be tailored to any company's situation,
its flip side is that it makes it illiquid.

It's not backed by collateral (unsecured), resulting in a higher coupon payment than senior
debt. It's usually medium term money, with maturities ranging from 5 to 7 years.
Generally, it requires only payment of interest, often including a PIK toggle (payment in
kind), allowing the underlying company to choose whether it will make required coupon
payments in the form of cash or in kind (capitalized interest).

Recovery if there is default from the company ranges between 20 - 30%.

Eight Characteristics of Mezzanine Debt

1. Board Representation: Subordinated lender generally expects to be considered


an equity partner.
2. Restrictions on the borrower: The mezzanine lender may have the right to
approve or disapprove any additional debt and require that any new debt be
subordinated to the original subordinated debt. The lender may also enjoy final
approval over any contemplated acquisitions, changes in management team or
payment of dividends.
3. Flexibility
4. Negotiations with senior creditors: The subordination generally comes with an
intercreditor agreement, where the existing creditors places restrictions on both
the senior and mezzanine lender. It can be directly negotiated between creditors
or between the mezzanine investor and the company.
5. Subordination: It may be either a blanket subordination or a springing
subordination. A blanket subordination prevents any payment of principal or
interest to the mezzanine investor until after the senior debt has been fully repaid.
A springing subordination allows the mezzanine investor to receive interest
payments while the senior debt is still outstanding. However, if a default occurs or
a covenant is violated, the subordination springs up to stop all payments to the
mezzanine investor until the default is cured or the senior lender is fully repaid.
6. Acceleration: The violation of any covenant may result in acceleration.
7. Assignment: Typically restricts the rights of the mezzanine investor to assign, or
sell its interest to a third party.
8. Takeout provisions: Allows the mezzanine investor to purchase the senior debt
once it has been repaid to a specified level. This is one of the most important
provisions in an intercreditor agreement because by taking out the senior debt, the
mezzanine investor becomes the most senior level creditor and in fact it takes
control of the company by converting the debt into equity through convertible
bonds or warrants, becoming the largest shareholder.

Six Basic Examples of Mezzanine Financing

1. Mezzaning financing for a management buyout (MBO) or leveraged buyout (LBO)


2. For growth and expansion
3. For an acquisition
4. To recapitalize a company
5. Commercial real estate
6. Bridge financing

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