Mezzanine debt is unsecured debt that sits above preffered equity and below secured debt in a company’s capital structure. This form of financing has become very popular with private equity in recent years, as rates can be relatively high compared to other forms of financing.
Q. So “mezz” is also often called “mezz debt”, very important to getting PE and RE deals, done, right?
A. Yes. Mezz stands for “mezzanine”, as in the mezzanine in a theater. Not on the top, not on the bottom, it sits between equity and secured debt in terms of repayment rights. As you know, secured creditors have rights to specific collateral of the borrower in the case of default. Mezz debt holders generally do not have that protection– they are typically unsecured creditors, and so the loans pay a higher rate of interest. But they collect before the common stockholders, so they’re in the middle, in the mezzanine.
Q. And these are always loans?
A. Usually. Some folks categorize preferred stock as mezzanine financing, because that, too, comes between the common and the debtholders. But preferred stock sits underneath any loans, secured or not, that the company has.
Q. And this is a real mainstay of the PE world, right?
A. Certainly for LBO type deals, yes. And because the rates are pretty high, as we just mentioned, so some PE funds specialize just in providing this sort of financing into other PE deals… in the golden era of PE a few years back, the banks were making tons of money with Mezz, and so the PE guys started competing with their own funds to provide it.
But you also see it with other kinds of corporate deals, say to fund an acquisition or even a special dividend for a company. The common characteristic is that the company is tapped out on its ability to borrow on a secured basis – they’d usually prefer that because it’s cheaper.
Q. And what about real estate developments?
A. Yes, there too. In those cases, you’ll often see the financing occur in the management company — instead of the actual project — to facilitate the lenders rights in case of default. Another term you hear in the real estate world is “the stack”: all the different sources of financing, that sit on top of each other to accumulate enough money to get the deal done.