When it comes to debt, mezzanine debt ranks somewhere between equity and senior debt. Borrowers often use it as a final step in the borrowing process after they know what senior debt and equity they have available. This causes mezzanine debt to take a flexible form, as it tends to mold to the specific needs of a borrower. That sounds great for the borrower, but forces the mezzanine lender to conform to the deal and squeeze between two established layers of capital. In doing so, they place their loan under the senior loan which puts them behind all of the bank debt. This is what makes mezzanine funds risk lenders. If the borrower faces some financial trouble, the mezzanine debt is less likely than the senior debt to be paid back in full. Furthermore, the mezzanine lender usually has only one loan exit and that is through the ongoing cash flow of the business. They enter into an intercreditor agreement with the senior lender which forces them to standstill and not get interest payments if the company defaults on the senior debt. So they lack the ability to aggressively recover their loan in a downside scenario. Finally, mezzanine funds are used by companies for transitional growth and acquisitions. Often the company can only repay the mezzanine principal if the borrower successfully grows. Essentially, without successful execution of the business plan, the repayment of mezzanine principal hangs in the balance. This is what makes a mezzanine lender a risk lender. They take real risk when they make their loans and have to make sure they are picking companies that will be successful and generate cash flow over the long term.
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