Posted on: January 21st, 2019
Mezzanine debt is a loan to a company based on its cash flow or EBITDA level. It is placed under a bank loan and on top of any equity investment, sandwiched between these two layers. It is a fundamentally different form of loan than traditional bank variety.
Mezzanine debt evolved from the corporate finance world of private equity in the 1970’s. Although it is called a loan, it shares more DNA with equity investment from a structuring and valuation perspective.
In short, if you are doing something big, whether an acquisition or expansion of some sort, you will likely need external capital to fund it. Banks can only supply a limited amount of your need, which results in a funding gap. You need a lender to go beyond collateral to fill your funding gap. The lender has to rely on the future cash flow growth of your business, for eventual repayment.
Mezzanine debt usually fills this funding gap. It’s a remarkably valuable form of capital because it costs significantly less than raising equity investment and gives you all the money your bank will not.Most lenders that use a mezzanine-like approach tend to define their loans from a legal- technical perspective, and not in terms of the value it creates for borrowers.
Its growth throughout the corporate finance world has spawned many new names for it. Some are old and some are new, but they all describe the same old mezzanine structure – cash flow based, and in second position beneath the senior lender. Here are a few of the many forms of capital that utilize the Mezzanine debt structuring approach.
- Subordinated debt, junior debt or junior capital.
- Second lien loan – the lender is in second position after the senior lender.
- Unitranche loan – this loan has two pieces, a senior and mezzanine, integrated into one structure.
- Term loan B – this complements a term loan A, usually provided by a bank.
- Growth debt – this is for rapidly growing tech companies and based on enterprise value.
- Cash flow-based loan.
- Structured or Preferred Equity.