Mezzanine debt

October 2018

Private debt is a component of many institutional portfolios and fills an important role, with distinct characteristics from other private asset classes. Compared to other private market vehicles, private debt can offer relatively stable returns and reduced risk across market cycles. This is due largely to debt’s senior position in the capital structure relative to equity and the ability for management to write in covenants to structure and protect their investments. Investors have a variety of different instruments to choose from in the private debt universe, all with unique return profiles, which can be beneficial to an investor’s portfolio.

Mezzanine debt is one such popular instrument that sits on the balance sheet at the “mezzanine” level, above shareholder equity but subordinated to all senior bank debt. Thus, if a company fails, mezzanine investors will be repaid from the proceeds of the liquidation only after the senior lenders have been made whole. Mezzanine loans are therefore considered to be higher risk loans, especially since most are unsecured by asset collateral, but investors are compensated for these risks through higher interest rates and transaction fees. While primarily a debt instrument (i.e., a loan), mezzanine financing may also include equity-like features, including options and warrants, which typically make up 15-25% of the total return.