Debt and alternative financing
What is mezzanine financing and when should I use it?
Short answer
Many sponsors look at mezzanine financing when senior debt does not cover the whole gap and they want to avoid selling more equity. It sits between bank debt and equity, tends to cost more than a bank loan, and often carries an equity feature like warrants. It tends to suit businesses with steady cash flow. I always say to match the money to what your investors want, and many sponsors talk to a securities attorney about the terms.
Where mezzanine sits and what it costs
Mezzanine financing is a layer of capital that sits below senior bank debt and above common equity. The ordering of who gets paid first is usually set out in the loan documents. Because mezzanine takes more risk, lenders often ask for a higher return than a bank does. The return is often described as a mix of interest and an equity feature, such as warrants or a conversion option. Terms vary a great deal from deal to deal, so I never assume two mezzanine offers look alike.
When it tends to make sense
The usual case is a gap. You have a senior loan, or one that is about to close, and it still leaves a hole between that loan and the full cost of the deal. A few signs that mezzanine may fit:
- A senior loan is in place or in process, but a funding gap remains
- The business has steady, predictable cash flow to cover higher interest
- You want to give up less ownership than a full equity raise would cost
- You are comfortable with a lender who has real rights if the plan slips
It fits poorly when cash flow is uncertain. The higher cost adds pressure, and a missed payment can create real pressure on the relationship with the lender. Many sponsors have a securities attorney review any term sheet before moving ahead.
Gap financing in practice
I have used a simpler version of this idea myself. Mezzanine is not what I did here. It was short-term notes, but the idea of filling a gap is the same.
In this clip I describe putting a little over a million dollars in notes into a company to bridge it to a larger debt facility.
That facility was about 20 million dollars and was set to close at the end of the month. The notes carried the company across the gap until the larger money arrived. That is the kind of creative financing I like, where each piece has a clear job.
Match the money to what your investors want
Before you pick any debt structure, look at who is actually writing the checks. I learned this the hard way. After 2008, banks were shutting down lines of credit, so I needed debt. I built a debt syndication and thought the packaging was great. I raised 25,000 dollars. My numbers made sense, but my investors wanted equity.
Mezzanine is debt-like money, so it only works if someone wants to provide it. Know your audience first. Then decide whether the structure suits them.
What a lender will look at
Expect a mezzanine lender to do heavy due diligence. They will want to see your financial statements, your cap table, and every loan and financing arrangement already on the books.
This due diligence checklist shows the financing and debt records that any serious capital provider will ask to review.
Summary and key takeaways from this video
Get those records in order early. A clean data room speeds up a deal and builds trust. I would also model your cash flow under a slow case, since mezzanine leaves less room for error than equity does.
On the record
- I put a little over a million dollars in notes into a company over about three months to bridge it to a larger debt facility.
- The debt facility being bridged was 20 million dollars and was set to close at the end of the month.
- My first debt syndication after 2008 raised only 25,000 dollars because my investors wanted equity, not debt.
Sources
From Richard C. Wilson's Centimillionaire Strategies YouTube channel: Top 3 Insights on Structuring Investments - PODCAST - Family Offices & Family Office Club, Evaluating Deals and Performing Due Diligence | Family Offices Group. Quotes come from the video captions, lightly edited for readability. Figures are the speakers' own estimates and experience.
General education only. Not legal, tax or investment advice.
Talk to a securities attorney to explore options around mezzanine loan terms, warrants and conversion rights and lender priority and remedies. Do not use AI to write your own legal agreements.
Where to start
- Write down the size of your funding gap after the senior loan.
- Model your cash flow in a slow case to see if you can carry higher interest.
- Ask your investors whether they prefer debt, equity or a mix.
- Gather your financial statements, cap table and existing loan documents.
- Consider talking with a securities attorney about any term sheet before moving ahead.
More questions on this
Is mezzanine financing the same as a second mortgage?
Not exactly. Both sit behind the first lender in general terms, but mezzanine often carries equity features like warrants. The details vary by deal, so many sponsors ask an attorney to explain the actual documents.
Does mezzanine financing dilute my ownership?
It can, if the lender receives warrants or a conversion option. Often it dilutes less than a full equity raise, but that depends on the terms of the deal.
Can I use bridge notes instead of mezzanine?
Sometimes. I have used short-term notes to carry a company to a larger debt facility. Bridge notes are generally meant to be temporary, while mezzanine is often longer term.
Related questions
- How does a bridge loan work for a real estate deal?A bridge loan is short-term money that covers a gap in a real estate deal.
- How do I raise private credit for my business?Start by deciding which side of private credit you need.
- How does asset-based lending work for growing companies?Asset-based lending is a loan secured by company assets such as receivables, inventory or equipment.
- What is venture debt and who qualifies for it?Venture debt is a loan made to a venture-backed company, usually alongside or after an equity round.
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