Mezzanine Finance

Companies with a market capitalization between $200 million and $2 billion use mezzanine financing to fill a gap in their capital structure.  They are too big for venture capital investors and too small to issue bonds.  Usually, the financing consists of an intermediate term bond with a equity warrant/option (also known as a kicker).  The bonds are below the senior debt and above the equity of the company.  They are unsecured by any assets.  A company may use this type of financing for a management buyout, growth and expansion, to buy another company, to recapitalize its balance sheet, real estate, in leveraged buyouts or as a bridge loan.  Mezzanine financing allows companies to raise money without diluting equity holders of its stock.

Funds that invest in mezzanine financing expect lower returns than venture capital or leveraged buyouts investments.  Generally, pensions, endowments and foundations are the buyside firms that invest in mezzanine funds.  They receive equity returns with less risk.  Mezzanine debt rank higher than equity and unsecured debt in case the company defaults.  The repayment has a specific schedule.  Mezzanine deals are less risky because they are not exposed to the J-curve effect.  The J-curve affects venture capital and leveraged buyout funds.  The initial years have a negative return as the fund managers search for investments and are incurring fees.  The profits are realized in later years.  The investors may be invited to the board of directors of the company issuing the debt and may impose restrictions such as not allowing additional debt to be issued, changing the management or suspending dividends.