What is Mezzanine Debt and Types of Mezzanine Debt?

Mezzanine debt is a type of financing that sits between senior debt and equity in a company’s capital structure. It is a riskier financing option than senior debt or ordinary debt for the investor, as it is considered less secure in the event of the company’s bankruptcy. However, it also offers a higher return to the investor and, therefore, the more financial cost for the company.

There are various types of mezzanine debt, differing based on the structure and terms of the debt. Some of the more common types of mezzanine debt include:

Convertible bonds: These can be converted into shares of the issuing company at a future time, which means that investors in convertible bonds assume an additional risk reflected in the interest rate of this form of financing.

Subordinated Loans: These loans have a lower repayment priority than other loans in case the company goes bankrupt.

Participative loan: The participatory loan is a type of financing that is in an intermediate position between equity and debt. Some characteristics of the participating loan are similar to those of debt since the lenders expect to receive the loan repayment with interest. However, it also shares some features with equity since the lenders have the right to participate in the company’s profits.

Preferred Stock: These are shares with limited voting rights and a higher redemption priority than equity if the company goes bankrupt.

Convertible debt: These loans can be converted into company shares at a future time. Convertible debt lenders assume a higher risk of default in exchange for a higher interest rate and the option to convert the loan into equity.

Debt with purchase option: These loans give the lender the option to purchase company shares at a fixed price at a future time.

It is essential to remember that each type of mezzanine debt has its own characteristics and terms. It is necessary to understand them before making a financing or investment decision, especially considering the possible long-term consequences on the company’s shareholder structure.

What is possible to finance with mezzanine debt

In general, mezzanine debt is used to finance expansion projects, either in the initial stages of the company’s life cycle or in mature settings to face growth phases, so the variety of needs that mezzanine debt can cover is wide and involves both working capital needs and long-term needs.

Some examples of what you could finance with mezzanine debt:

Acquisition of assets: One of the most common destinations for mezzanine debt is to finance the purchase of assets such as machinery, equipment, real estate or industrial property. In general, any non-current asset can be funded with mezzanine debt. Business Expansion – It is possible to use it to finance the expansion of the business, either through the acquisition of new companies or the opening of recent locations.

This phase includes investment and working capital needs; the mezzanine debt can cover both.

Launch of new products or services: It is possible to use mezzanine debt to finance the launch of new products or services, such as the research and development of new technologies or the creation of new product lines.

Company reorganization: It is possible to allocate mezzanine debt to finance the company’s reorganization, such as debt restructuring or supply chain optimization.

Can SMEs be financed with mezzanine debt?

Yes, an SME (small and medium-sized company) can obtain mezzanine debt as part of its financing structure.

To obtain mezzanine debt, the SME must demonstrate a strong growth history and a long-term profitability outlook. In addition, investors in mezzanine debt often require collateral or a company stake to protect against default risk. It is also possible to finance a newly created company with mezzanine debt, although it must demonstrate that the project is profitable in the long term and that the management team is good.

There are several ways to get mezzanine debt. Some of the options that can be considered, for example:

Investment funds: Many investment funds offer mezzanine debt as a financing option for companies. It is possible to find them in public records.

Banks: Some banks offer mezzanine debt through products such as subordinated loans or convertible bonds. It is usually provided by the corporate banking division and is rarely seen in small companies. Private Investors: It is possible to find private investors willing to invest in the company through mezzanine debt. Several Participatory Financing Platforms offer it, as well as groups of investors attached to business schools and universities where it is possible to get in touch with them, generally through investor forums.

Public bodies: Many public bodies offer mezzanine debt, such as the participatory loan or subordinated debt. It is one of the main channels for smaller companies to access it.

It is important to note that raising mezzanine debt can be more difficult for SMEs than large corporations, as investors in mezzanine debt are often more reluctant to take on the higher default risk associated with SMEs. Therefore, it is essential to explore all the financing options available and evaluate which is the most appropriate for the needs that are intended to be covered.