In this blog, we are discussing Mezzanine Debt in detail. Get to know what it is exactly and why it is preferred to finance anything from a property to a leveraged buyout, and everything in between.
Mezzanine Debt – An Insight
Mezzanine debt occurs when a hybrid debt issue (a type of debt with some features of equity) is subordinated to another debt issue from the same issuer.
Mezzanine debt comes with equity instruments attached – known as warrants – which enhances the value of the subordinated debt and allows greater flexibility while dealing with bondholders. It is greatly associated with acquisitions and buyouts, where it is used to prioritize new owners rather than the existing owners in the case of bankruptcy.
In other words, Mezzanine debt blurs the lines between everything that constitutes debt and equity. Although, this type of debt involves the highest-risk, it offers some of the highest returns (rate ranges between 12% – 20% per year).
A mezzanine lender is brought into a buyout in order to displace some part of the capital that is invested by an equity investor.
General Examples of Mezzanine Debt
Some examples of embedded options may include rights, stock call options, and warrants. Generally, mezzanine debt acts more like a stock than debt as the embedded options make the conversion of the debt into stock.
Let’s understand it by an example.
Let’s say, a private equity firm desires to buy a company worth $100 million with debt. But the senior lender only wants to invest 80 % of the value, and the private equity could not invest more than 10% of the remaining capital. In this case, the private lender would look out for a mezzanine investor to finance another $5 million, then, the firm only has to invest $5 million to meet up the $100 million.
The investor here used the mezzanine debt. That means, he will be able to convert the debt to equity when certain requirements are satisfied.