Financial Glossary
Mezzanine financing
Mezzanine financing occupies the capital structure between senior secured debt and common equity. It is typically structured as subordinated debt -- sometimes with attached equity warrants or a conversion feature -- making it higher risk than senior loans but offering higher yields to compensate lenders. Because it is unsecured or junior-lien, lenders charge interest rates significantly above senior debt. If the borrower defaults, mezzanine lenders are paid only after senior creditors are whole. The equity kicker (warrant or conversion right) allows the lender to share in upside if the company grows. Common in leveraged buyouts, real-estate bridge deals, and growth-stage company financings.
Problem & Application
A campground owner wants to acquire a 120-site park for $4,000,000. A bank will lend $2,800,000 (70% LTV) as senior debt. The owner has $600,000 in equity, leaving a $600,000 gap. A mezzanine lender fills that gap at a 14% interest rate with warrants for a 10% equity stake. The all-in acquisition is funded: $2,800,000 senior + $600,000 mezzanine + $600,000 equity. Annual mezzanine interest cost = $84,000. If the park sells in five years at $5,500,000, the mezzanine lender also participates in 10% of the equity proceeds. For owners, mezzanine allows larger acquisitions without diluting control through outside equity partners, but the interest burden must be stress-tested against seasonal cash flow dips. Underwriting mezzanine requires conservative DSCR analysis at full debt load.
In Short
Mezzanine financing is a valuable option for businesses seeking capital for growth but should be used with caution due to the potential cost and risk.