Mezzanine debt occurs when a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments attached, often known as warrants, which increase the value of the subordinated debt and allow greater flexibility when dealing with bondholders. Mezzanine debt is frequently associated with acquisitions and buyouts, for which it may be used to prioritize new owners ahead of existing owners in case of bankruptcy.
KEY TAKEAWAYS
- Mezzanine debt is when a hybrid debt issue is subordinate to another debt issue from the same issuer.
- Mezzanine debt bridges the gap between debt and equity financing and is one of the highest-risk forms of debt—being subordinate to pure debt but senior to pure equity.
- In practice, mezzanine debt behaves more like a stock than debt because the embedded options make the conversion of the debt into stock very attractive.
- Mezzanine debt offers some of the highest returns when compared to other debt types, often generating rates between 12% and 20% per year.
