What is the structure of mezzanine finance?
Mezzanine financing sits in a company’s capital structure between its senior debt and its equity, as subordinated debt, preferred equity, or a combination of the two.
Mezzanine finance is most often structured as unsecured subordinated debt, or sub-debt, indicating it is inferior to senior debt and it does it present any ownership to the lender. Sub-debt is only protected by the borrower’s promise to pay, meaning it can be high-risk. However, some mezzanine financing will take an underlying lien on the organisation’s property, which may provide some security.
Preferred equity is an equity investment in a property-owning business, and it is usually subordinate to mortgage loans and any mezzanine loans but is senior to common equity. Preferred equity is generally deemed to be a higher risk than other mezzanine debt due to increased risk and lack of collateral.
Mezzanine loans usually require monthly payments as debt service and can only be converted to equity in the event of the borrower defaulting in the loan. Depending on the size of the loan compared to the value of the equity, mezzanine debt has the potential to deliver majority ownership to the lender if a distressed debt to equity conversion takes place.