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Subordinated debt sitting between senior lending and equity, usually carrying an equity kicker.
Mezzanine debt is subordinated lending that ranks below senior secured debt but above equity. Because it absorbs loss before senior lenders do, it carries a higher rate, and it is usually paired with warrants or conversion rights so the lender participates in upside.
It exists to fill the gap between what senior lenders will advance and what the sponsor wants to fund with equity.
Most common in leveraged buyouts, recapitalisations, and growth financings for established, cash-generative businesses. A sponsor uses senior debt for the bulk of a transaction, mezzanine to bridge the remainder, and equity for the balance — reducing the equity cheque without ceding control.
Provides substantial capital with far less dilution than equity, and mezzanine lenders typically take no board control. It is expensive, and payment-in-kind interest compounds quietly — the balance owed can grow materially before any cash leaves the business.
Returns combine a high contractual coupon with equity upside, and the position sits above equity in a downside. The risk is genuine subordination: in a distressed scenario, senior lenders are satisfied first and mezzanine can be substantially impaired.
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