Mezzanine Debt

Full Definition

Mezzanine debt occupies the middle of the capital structure—junior to senior secured lenders but senior to equity holders. Because mezzanine lenders accept lower repayment priority (they are paid after senior debt in a liquidation or restructuring), they demand higher returns: total yields of 12–20% are typical, often comprising a cash interest component (8–12%) plus a PIK (payment-in-kind) interest component and frequently an equity kicker in the form of warrants or a small equity co-investment right. This equity participation upside compensates for the higher default risk inherent in the subordinated position. Traditional mezzanine debt is used when the company needs more debt than senior lenders will provide but the sponsor wants to avoid issuing additional equity that would be more dilutive. A buyout financed with $100M of senior debt at 5.0x EBITDA might add $25M of mezzanine at 6.25x EBITDA to achieve the target leverage without additional equity. The mezzanine lender accepts a higher risk position in exchange for significantly higher yield and equity participation. The growing prevalence of the second-lien term loan market has reduced traditional mezzanine usage in broadly syndicated leveraged buyouts, but mezzanine remains common in middle-market transactions where capital markets access is more limited. Structurally, mezzanine debt is typically unsecured or secured by a second lien on assets, with cash interest paid quarterly or semi-annually and PIK interest accreting to principal balance. Intercreditor agreements between senior and mezzanine lenders govern the mezzanine holders' rights during a default or restructuring—specifically limiting their ability to exercise remedies, receive asset sale proceeds, or accelerate their debt before senior lenders have been satisfied. Understanding intercreditor provisions is critical for mezzanine lenders assessing actual downside protection in a distress scenario.

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