Mezzanine loans are subordinated, higher-cost debt instruments used to fill financing gaps in buyouts, growth capital, and real estate. Lenders earn returns from fees, cash interest, payment-in-kind, and equity kickers. These loans rank below senior debt, carry greater refinancing risk, and are most commonly provided by private credit funds and specialty lenders.

What a mezzanine loan is

A mezzanine loan is a form of subordinated debt that sits between senior bank debt and equity in the capital structure. It is commonly used to fill the gap between what senior lenders will provide and the total financing a company or real estate project needs.

Mezzanine debt is typically medium-term (commonly 3-7 years), higher-cost, and either unsecured or secured by an equity pledge rather than first-priority liens on operating assets. Lenders accept the higher risk in exchange for higher expected returns and downside protections.

Key features and components of return

Mezzanine structures vary, but lenders generally seek returns from a combination of sources:

  • Arrangement or origination fees paid up front.
  • Periodic cash interest paid during the life of the loan.
  • Payment-in-kind (PIK) interest, which accrues and is added to principal if cash payments are deferred.
  • An equity kicker, often in the form of detachable warrants, options, or a convertible feature that lets the lender capture upside if the company performs well.
These elements let lenders participate in upside while limiting their exposure compared with equity investors.

Common uses

  • Leveraged buyouts and acquisitions, where mezzanine fills the capital gap after senior debt and sponsor equity.
  • Growth financings for companies that need capital but want to limit immediate equity dilution.
  • Real estate development or acquisition capital structures, where mezzanine may be secured by a pledge of the developer's equity or a second lien on the project.

Risks and lender protections

Mezzanine debt carries higher interest rates than senior debt because it ranks below senior lenders on repayment and collateral claims. That subordination increases refinancing and default risk; borrowers often depend on strong cash flow or an exit event (sale or IPO) to repay or refinance mezzanine obligations.

Lenders protect themselves with contractual covenants, intercreditor agreements that define rights relative to senior lenders, and equity kickers that compensate for downside risk. Because mezzanine lenders expect higher returns, they focus on companies with clear growth prospects or assets suitable for a sale or recapitalization.

Market context (modern practice)

Mezzanine capital is most often provided today by private credit funds, specialty finance lenders, and institutional investors rather than traditional commercial banks. Its structures have evolved to include more flexible covenants and hybrid instruments (convertible features, preferred equity-like structures) to match borrower needs while preserving lender returns.

FAQs about Mezzanine Loans

How does mezzanine debt differ from senior debt?
Mezzanine debt ranks below senior debt for repayment and collateral claims, typically carries higher interest, and often includes equity kickers such as warrants. Senior debt has priority repayment and usually lower interest and stricter collateral claims.
What is a payment-in-kind (PIK) feature?
PIK allows interest to accrue and be added to the loan principal instead of being paid in cash during the loan term. It preserves borrower cash flow but increases the outstanding balance to be repaid later.
When do companies use mezzanine financing?
Companies use mezzanine financing to bridge funding gaps in leveraged buyouts, to finance growth without immediate equity dilution, or in real estate projects where additional non-senior capital is needed.
Who provides mezzanine capital today?
Private credit funds, specialty finance lenders, and institutional investors are the primary providers of mezzanine capital, rather than traditional commercial banks.
What protections do mezzanine lenders typically require?
Lenders use contractual covenants, intercreditor agreements with senior lenders, equity kickers (warrants or convertibility), and sometimes equity pledges to protect returns and recovery prospects.