Mezzanine Capital –
simply explained

Key facts at a glance:

• Mezzanine capital combines features of both equity and debt capital. Money is lent for a limited period and must be repaid with interest and principal.

• In most cases, a profit share is also included. A say in the company, on the other hand, is rather uncommon.

• Mezzanine financing can improve the equity ratio and is often treated as subordinated by other lenders.

• Mezzanine financiers do not require tangible collateral. However, interest rates are generally high. Moreover, this type of capital is designed for long terms and high loan amounts.

What Is Mezzanine Capital?

Mezzanine capital is also referred to as "hybrid capital" or "mixed financing". The term does not stand for a single, clearly defined financing model, but rather as a collective term for a whole range of different approaches.

What all of these have in common is hinted at by the term "mezzanine" — Italian for "half" or "mezzanine floor": the financing arrangements sit between equity and debt capital and combine features of both types.

Similar to a debt capital loan, money is lent here that must usually be repaid with interest and principal after a certain period. However, if the company makes a profit during the term, the interest can also increase. Such a profit share is a typical equity characteristic of mezzanine financing.

What Special Features Does Mezzanine Capital Have?

Companies receive equity-like funds within the framework of mezzanine financing, usually without having to grant capital providers influence over the company's management. These providers do not, for example, have voting rights as is otherwise customary for shareholders. This is why the terms "silent partnerships" or granted "participation rights" are also used.

Another special feature of mezzanine capital comes into play through its subordination. This means that in the event of insolvency, the claims of mezzanine capital providers are only serviced after those of regular debt capital providers — but before those of equity providers.

Where Does Mezzanine Capital Come From and What Is It Used For?

Originally, this type of financing comes from management buy-outs — a form of company acquisition. Today, mezzanine capital is also used in the financing of growth or expansion projects, among other things. For long-term projects with high initial expenditure that only pays off after several years, companies also turn to mezzanine capital.

Typical mezzanine financiers are private equity firms, mezzanine funds or independent investors. Banks usually only play the role of intermediary in most cases.

The Advantages and Disadvantages of Mezzanine Financing

Mezzanine capital expands the range of bank-independent financing options for companies. The hybrid nature of the approach can also increase the equity ratio without having to give up company shares or influence.

Due to its proximity to equity, the balance sheet and creditworthiness can often be optimised, which can improve the prospects for additional bank loans. Mezzanine lenders also generally do not require tangible collateral.

This waiver of collateral and the higher risk from the long terms are usually compensated by correspondingly higher interest rates. On top of that, there is usually the aforementioned profit share.

Moreover, mezzanine financing is often only available from seven-figure sums upwards and only for periods of ten years or more.

Added to this are the requirements placed on companies: many models require an established market position, promising growth forecasts and a stable cash flow.

Mezzanine capital is also not necessarily recognised as equity by banks. This often only occurs when the mezzanine term is longer than the envisaged loan.

Furthermore, this type of financing is only accepted as subordinated by most credit institutions when an explicit subordination declaration from the mezzanine provider is available.