Mezzanine Debt

economic-dictionary

Mezzanine debt is a hybrid between debt and stocks. It is classified as a type of debt, not as a form of financing, therefore, it is not a type of operation carried out by private equity itself. In other words, in some way they represent collection rights over the companies in the underlying portfolio.

In the order of priority that we present below, the upper part (Senior Secured debt) in the event of bankruptcy by the issuer of the debt will be the first to collect and the lowest part, the last to collect (shares). Mezzanine debt is just below the aforementioned Senior Secured debt and can go as far as equities.

The most typical form that this type of debt takes is that of a medium-term bond with some form of leveraged or subsidized action. This type of leveraged or bonus share can be options, warrants or any type of financial asset with the same characteristics. For its part, the bond can have the structure of payment in cash or in kind, so that the debt is paid with additional debt.

Ultimately, mezzanine debt can take the form of Senior Subordinated debt, Subordinated Convertible debt in shares or Convertible Preferred debt in shares.

What is mezzanine debt used for?

Mezzanine debt financing is used to fill financing gaps as a business grows and evolves.

These gaps or voids can come from several causes:

  • Gaps in time. A private company has exhausted all its capital that comes from an initial venture capital, but is trying to reach the next stage, which would be the IPO.
  • In the capital structure of the company. Mezzanine debt offers financing beyond what lenders are willing to lend, but without significantly diluting shareholders.)
  • In an operation of leverage buyout (This type of debt can be used to complete financing needs in an LBO operation).

What type of companies use this type of debt?

In general, the companies that use this type of financing are usually those that belong to the middle market (middle-market), between 200 and 2 trillion of market capitalization. The use of this type of debt is necessary for this type of companies dependent on private equity, to be able to finance themselves in the capital markets and compete with large companies.

High-yield bonds or also known as high yield, along with large leveraged loans are only available to large companies, hence their great dependence as we said on the private equity.

Mid-market companies use this financing with a range of between 5 and 50 million euros. The debt structure is negotiated through the counterparties, making it much more illiquid than high-yield bonds or large leveraged loans for large companies.

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