The Risks and Rewards of Mezzanine Debt in Acquisition Financing

Posted on: June 17th, 2025

mezzanine-debt

Acquisition Financing can unlock a transformative growth journey fraught with risk and reward. Mezzanine debt plays a versatile role in this journey as both a capital resource extender and an equity substitute thereby providing more capital availability at lower cost. It provides more capital than a bank loan at a much lower cost than equity.

However, mezzanine debt requires a careful balance within an acquisition financing structure due to its inherent risks and rewards. It is tempting to overfocus on the upside of mezzanine debt as it allows a buyer to bring more capital to a table reducing the amount of equity necessary. This reward is a powerful aphrodisiac for acquirers especially independent ones who lack the funding power of PE funds.

Mezzanine debt is also expandable and can provide funding for multiple acquisitions in a series. This scalability reward makes it great for companies that have an aggressive plan. While you can use mezzanine debt extensively in your acquisition financing, the risk overleveraging looms large. All deals need a good amount of cash equity to provide elasticity to the capital structure without which the company may easily get stuck.

Companies with too much debt are usually running hand to mouth on a liquidity treadmill and can never see beyond the next few months. There is little extra cash to invest in new growth, new systems or new direction. Without fresh growth investment, the company gets stale and loses its edge leading to a gradual erosion in business value. The loan principal must also be repaid through future cash flow growth which puts pressure on the business to perform according to plan.

When a company underperforms, it creates risk as to the ability to make future loan payments. The risk of illiquidity is omnipresent in mezzanine debt deals which underscores the importance of having equity available and sound liquidity management practices. While mezzanine debt can create huge return upside, it can also lead to a less stellar outcome when overleveraged.

There are many best practices regarding acquisition financing available on the web. These widely disseminated rules tend to state the obvious that apply to all types of loans, regardless of the complexity of the deal. These rules focus on careful review and analysis of the terms and conditions of the acquisition financing to ensure you clearly understand the pricing, fees and reporting obligations post-closing.

Mezzanine debt often functions as a gap-filler in middle market deals. As crossover capital, it provides equity-level funding with debt-like properties thereby providing more capital at lower prices for companies. Mezzanine debt also unlocks more aggressive growth scenarios unavailable through bank loan structures.