Mezzanine debt ("mezz," or subordinated debt) is financing that sits between senior debt and equity in a company's capital structure — the "mezzanine" floor. It is subordinated to senior loans (paid only after they are satisfied) but ranks ahead of equity, and it carries equity-like features that make it a hybrid of the two. It is a workhorse of leveraged buyouts, growth financings and recapitalisations.
Where it sits and why it costs more
In the capital "stack," risk and return rise as you move down from senior debt to equity. Mezzanine occupies the middle:
| Layer | Risk | Typical cost |
|---|---|---|
| Senior debt | Lower | Lower |
| Mezzanine | Medium-high | ~12–20% all-in |
| Equity | Highest | Highest (target returns) |
Because mezzanine lenders are subordinated and usually unsecured, they demand a much higher return than senior lenders — typically a high-teens all-in cost — to compensate for the greater risk of loss in a downturn.
Its hybrid features
What distinguishes mezzanine from ordinary subordinated debt is its equity-like components:
- PIK ("payment-in-kind") interest. Rather than paying all interest in cash, part of the return accrues and compounds onto the principal, easing the borrower's near-term cash burden — valuable for a leveraged company that needs to conserve cash early on.
- Warrants — the "equity kicker." Mezzanine lenders often receive warrants (the right to buy equity) so they share in the upside if the company succeeds. This kicker is how a mezz lender earns equity-like returns while holding a debt instrument.
Why borrowers use it
Mezzanine fills the gap between how much senior debt a lender will provide and how much equity a sponsor wants to contribute. By slotting in mezz, a buyer can complete the LBO capital structure with less equity, boosting equity returns. It is also more flexible and patient than senior debt — looser covenants, often bullet maturities, and a lender comfortable with leverage — which suits acquisitions, expansions and recaps. The cost of that flexibility is the high coupon and the dilution from the equity kicker.
Mezzanine vs unitranche
Historically, a mid-market buyout might stack a senior loan + a separate mezzanine tranche, each with its own lender and documents. Increasingly, a single unitranche facility — blending senior and subordinated risk into one instrument at one blended rate — replaces that two-tranche structure, simplifying execution. Mezzanine remains important where a deal needs a distinct, patient, junior capital layer or an explicit equity kicker.
See also
- Leveraged buyout — An acquisition financed largely with borrowed money, repaid from the target’s cash flows.
- Unitranche — A single debt instrument that combines senior and subordinated tranches in one document at a blended rate, increasingly used in mid-market LBOs in lieu of separate credit facilities.
- Seller financing — A note from the buyer to the seller for a portion of the purchase price, typically subordinated to senior debt. Common in lower-mid-market and main-street deals as a bridge between buyer cash and bank financing.
- Leveraged recapitalisation — A transaction in which a company borrows substantial debt and uses the proceeds to repurchase shares or pay a special dividend, increasing leverage and (often) returning capital to owners.
- Dividend recapitalisation — A specific form of leveraged recap in which the proceeds are paid out as a dividend to equity holders. Most common in private-equity portfolio companies seeking interim returns.