Posted on: October 12th, 2023
Certain finance lexicon, due to unusual descriptive words used in the specific term, have less than obvious meanings. Mezzanine debt is one such word that baffles most people including people that can benefit most from its transformative power. The word mezzanine is classically an architectural term and means a low story between two others in a building typically between the ground floor and the first floor. The New York City subway system has many signs for the mezzanine level, which is usually above where you catch the train but below street level. It is the level between two others, one below and one above.
When first used in the 1970’s, the deal structurer obviously had some architectural background and used this adjective to denote the middle story of a three-level structure containing senior debt on the top level, the equity layer on the bottom level and mezzanine debt in the middle. Mezzanine debt was used as the middle layer in a leverage buyout transaction to fill the area beyond the bank loan, but before the equity layer. If a bank would fund all the way to the equity level, then there would be no need for mezzanine debt financing.
Usually, due to the acquisition price, the bank is not able to stretch that far which creates open space in the middle of the transaction structure for the mezzanine debt lender to fill. As the middle level, it combines elements of both the upper level and the lower level in its DNA, giving it a level of versatility and cost attractiveness. As the middle level, it has a bird’s eye view of the innerworkings of all the levels of a transaction structure, allowing it to customize its approach to be more senior debt like or more equity like, depending on the need of each deal.
What is patently true is that engineering your deal structure with mezzanine debt brings significant benefit to the buyer. It can provide equity like funding at a fraction of the cost of equity. It can provide a scalable funding approach to acquisitions at a very compelling cost of funds. Unfortunately, the strangeness of the mezzanine moniker belies the value it provides as a truly unique form of capital suitable for driving any type of growth. Perhaps a more appropriate name based on its track record of great outcomes would have been superstar capital.