How Does Mezzanine Financing Work?
Mezzanine financing is also known as subordinated debt, which ranks below senior debt, but above equity in priority of payment. When a company determines that it’s not capable of financing its growth plans with senior debt, the first step is to partner with a financial institution to locate an investor willing to provide capital in the form of long-term subordinated debt, usually carrying a fixed interest rate. Generally, these loans do not involve ownership or management participation, however they do include success fees or warrants to purchase equity at a later date. Most buy-back provisions for success fees or warrants are structured to give the investor more than just one type of payoff. In most deals, the value of the warrants are determined based on a multiple of earnings, or as a percentage of the company’s book value or enterprise value. This structure, assuming the company performs as planned, will yield a minimum compounded annual rate of return 20% to 22% over the life of t
