Mezzanine Debt

 

Mezzanine capital, refers to a subordinated debt or preferred equity instrument that represents a claim on a company’s assets which is senior only to that of the common shares. Mezzanine financing’s can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.

Mezzanine capital is often a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financing’s is the result of it being an unsecured, subordinated obligation in a company’s capital structure (i.e., in the event of default, the mezzanine financing is only repaid after all senior obligations have been satisfied). Additionally, mezzanine financing’s, which are usually private placements, are often used by smaller companies and may involve greater overall levels of leverage than issues in the high-yield market; as such, they involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or more senior lenders.

Mezzanine debt typically incorporates equity-based options, such as warrants, with a lower-priority debt piece. Mezzanine debt is actually closer to equity than debt, in that the debt is usually only of importance in the event of bankruptcy. Mezzanine debt is often used to finance acquisitions and buyouts, where it can be used to prioritize new owners ahead of existing owners in the event that a bankruptcy occurs.

Mezzanine financing’s can be completed through a variety of different structures based on the specific objectives of the transaction and the existing capital structure of the company. The basic forms used in most mezzanine financing’s are subordinated notes and preferred stock. Mezzanine lenders, typically specialist mezzanine investment funds, look for a certain rate of return which can come from interest, a cash equivalent (equity) or PIK Interest.

shadowed-oil-tanksThe interest rate charged the borrower can be either fixed throughout the term of the loan or can float along with LIBOR or other base rates. PIK interest (Payable in kind interest) involves a periodic form of payment in which the interest payment is not paid in cash but rather by increasing the principal amount by the amount of the interest accrued. lastly, along with the typical interest payment associated with debt, mezzanine capital will often include an equity stake in the form of attached warrants or a conversion feature similar to that of a convertible debt. The ownership component in mezzanine securities is almost always accompanied by either cash interest or PIK interest, and, in many cases, by both.

Mezzanie debt is not cosnidered “Cheap” money but, in many cases, the best form of financing for a specif tye of transaction. HFS can help our clients with the development of a mezzanie lender database with introductions to mezzanine lenders.