What Is Mezzanine Debt?

Mezzanine debt occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the attractiveness of the subordinated debt and allow greater flexibi🌞lity when dealing with bondholders.

Mezzanine debt is frequently associated with acqu✱isitions and buyouts, for which it may be used to rank new owners higher than existing owners in the stakeholder seniority list in case of company liquidation.

Understanding Mezzanine Debt

Mezzanine debt bridges the gap between debt and 澳洲幸运5官方开奖结果体彩网:equity financing and it's one of the highest-risk forms of debt. It's senior to pure equity but subordinate to pure debt but it also offers some of the highest returns when compared to other debt types. It often receives rates between 12% and 20% per year, even going as high as 40% in high-leverage cases.

Types of Mezzanine Debt

The types of equity included with the debt can be many. Some examples of embedded options include stock 澳洲幸运5官方开奖结果体彩网:call options, 澳洲幸运5官方开奖结果体彩网:rights, and warrants.

Mezzanine debt structures are most commonly found in leveraged buyouts. A private equity firm might seek to purchase a company for $100 million with debt but the lender only wants to ܫput up 80% of the value and offers a loan of $80 million. The private equity firm doesn't want to put up $20 million of its own capital and instead looks for a mezzanine investor to finance $15 million.

The firm then only has to invest $5 million of its own dollars to meet the $100 million price tag. The investor used mezzanine debt so they'll be able to convert that debt to equity when certain requirements are met. Using this method of financing leverages the buyer's potential return while minimizing the amount of capital that it must put up for the transaction. 

A hybrid security classification on the balance sheet under U.S. Generally Accepted Accounting Principles (GAAP) is dependent on how the embedded option is influenced by the debt portion. The two parts of the hybrid (the debt and the embedded equity option) must be classified in both the liability and 澳洲幸运5官方开奖结果体彩网:stockholders' equity sections of the balance sheet if the act of exercising th💦e embedded option is influenced by the structure of the debt in any way.

Example of Mezzanine Debt

Mezzanine debt is most often used in 澳洲幸运5官方开奖结果体彩网:mergers and acquisitions. Olympus Partners, a private equity firm based in Connecticut, received debt financing from Antares Capital in 2016 to acquire AmSpec Holding Corp, a company that provides testing, inspection, and certification services for petroleum traders and refiners.

The total amount of the financing was $215 million. This included a 澳洲幸运5官方开奖结果体彩网:revolving credit facility, a 澳洲幸运5官方开奖结果体彩网:term loan, and a delayed draw term loan. Antares Capital provided the total capital in the form of mezzanine debt, thus giving it equity options.

The Bottom Line

Mezzanine debt is the result of a hybrid debt issue being subordinated to another debt issue from the same issuer. It's often used in mergers and acquisitions. It provides a bridge between debt and equity financing and it shares several characteristics with stocks. Returns can range up to 20% annually (up to 40% in certain circumstances), making this type of debt an attractive option for investors over other debt types.