Mezzanine Debt
What Is Mezzanine Debt?
Mezzanine debt happens when a hybrid debt issue is subordinated to one more debt issue from a similar issuer. Mezzanine debt has embedded equity instruments appended, frequently known as warrants, which increase the value of the subordinated debt and permit greater flexibility while dealing with bondholders. Mezzanine debt is every now and again associated with acquisitions and buyouts, for which it very well might be utilized to focus on new owners ahead of existing owners in case of bankruptcy.
Grasping Mezzanine Debt
Mezzanine debt overcomes any barrier between debt and equity financing and is one of the highest-risk forms of debt. It is senior to pure equity yet subordinate to pure debt. Nonetheless, this means that it additionally offers the absolute highest returns when compared to other debt types, as it frequently gets rates somewhere in the range of 12% and 20% each year.
Types of Mezzanine Debt
The types of equity included with the debt can be quite a large number. A few instances of embedded options incorporate stock call options, rights, and warrants. In practice, mezzanine debt acts more like a stock than debt in light of the fact that the embedded options make the conversion of the debt into stock exceptionally attractive.
Mezzanine debt structures are most common in leveraged buyouts. For instance, a private equity firm might look to purchase a company for $100 million with debt, however the lender just needs to put up 80% of the value, offering a loan of $80 million. The private equity firm would rather not put up $20 million of its own capital and on second thought searches for a mezzanine investor to finance $15 million.
Then, at that point, the firm just needs to invest $5 million of its own dollars to meet the $100 million price tag. Since the investor utilized mezzanine debt, they'll have the option to switch the debt over completely to equity when certain requirements are met. Utilizing this method of financing use the purchaser's expected return while limiting the amount of capital it needs to put up for the transaction.
Under U.S. Generally Accepted Accounting Principles (GAAP), a hybrid security classification on the balance sheet is dependent on what the embedded option is meant for by the debt portion. In the event that the act of practicing the embedded option is affected by the structure of the debt in any capacity, then the two parts of the hybrid — the debt and the embedded equity option — should be classified in both the liability and stockholders' equity areas of the balance sheet.
Illustration of Mezzanine Debt
Mezzanine debt is most frequently utilized in mergers and acquisitions (M&A). For instance, in 2016, Olympus Partners, a private equity firm situated in Conn., received debt financing from Antares Capital to secure AmSpec Holding Corp, a company that gives testing, inspection, and certification services for petroleum traders and purifiers.
The total amount of the financing was $215 million, which incorporated a revolving credit facility, a term loan, and a delayed draw term loan. Antares Capital gave the total capital as mezzanine debt, consequently, giving it equity options.
Features
- Mezzanine debt is the point at which a hybrid debt issue is subordinate to one more debt issue from a similar issuer.
- Mezzanine debt overcomes any barrier among debt and equity financing and is one of the highest-risk forms of debt — being subordinate to pure debt yet senior to pure equity.
- Mezzanine debt offers probably the highest returns when compared to other debt types, frequently generating rates somewhere in the range of 12% and 20% each year.
- In practice, mezzanine debt acts more like a stock than debt in light of the fact that the embedded options make the conversion of the debt into stock exceptionally attractive.
