Mezzanine debt is typically used by companies that are cash flow positive to fund growth, a new product line, acquisitions, recapitalizations, and management and leveraged buyouts. When mezzanine debt is used in conjunction with senior debt it reduces the amount of equity required in the business.
Mezzanine debt is usually the intermediate debt between a company's senior debt and equity. It is subordinate to the senior lender but has priority over the equity in the company.
Some closely held companies are hesitant to consider mezzanine financing because it requires relinquishing a certain amount of ownership. However, a mezzanine investor's goal is to achieve a target return rate by some specified time. The typical mezzanine transaction has the mezzanine fund as a minority equity holder, with buyout terms to remove the mezzanine fund at the appropriate time.
The most significant benefit to mezzanine financing is that it lowers the equity required for a particular transaction. Typically, mezzanine investors are looking for an internal rate of return somewhere in the neighborhood of 15% to 30%.
Typically, mezzanine lending includes both subordinated debt and an equity component. The debt is issued with a cash pay interest rate of 12% to 18% and a maturity ranging from five to seven years with the ability of the borrower to buy out the debt earlier.
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