MEZZANINE AND SUBORDINATED DEBT

Mezzanine and subordinated debt: the tranche between debt and equity

TELL US ABOUT YOUR DEAL

Mezzanine and subordinated debt sit between bank debt and shareholders’ equity. They are repaid after the bank and before the shareholders. That is why they cost more than a bank loan, but they let you complete the financing of a deal without bringing in a new partner or giving up control.

At Manifest we structure this tranche and fit it with the rest of the financing.

If any term is unfamiliar, it is explained in our financing glossary.

STRUCTURE

Where it sits: the capital structure

The financing of a company or a project can be seen as a risk ladder, from top to bottom:

  1. Senior debt. First to be repaid, usually with the main collateral. It is the cheapest finance: the bank loan or the development loan.
  2. Mezzanine and subordinated debt. Repaid after the senior debt. It takes more risk and its cost is in between. It can include a share in the result of the deal.
  3. Equity. Last to be repaid and the one taking the most risk. It carries voting rights and the profits of the company or project.

The further down the ladder, the more risk the provider of the money takes and the higher the return it requires.

WHEN

When it makes sense

  • A growth plan or an acquisition the bank will not fully finance, and where you do not want a partner.
  • A development short of part of the equity required by the development loan.
  • A management buy-out or a generational handover.
  • A refinancing that needs an additional tranche above the bank debt.
  • Companies with predictable cash flows that can carry the cost in exchange for avoiding dilution.

STRUCTURES

Common forms

The most common structures for this tranche:

Subordinated loan

A loan that, if things go wrong, is repaid after the senior debt.

Participating loan

Interest depends partly on the company’s results. Under Spanish company law it counts as equity for the purposes of capital reduction and dissolution, which strengthens the balance sheet.

Mezzanine with an equity kicker

On top of interest, the lender receives a share of the deal’s result or a right over the equity.

Junior debt in developments

A tranche behind the development loan to cover part of the equity the developer does not put in. Land and development finance.

BALANCE

Advantages and what to weigh up

It costs more than a bank loan, but usually less than giving up part of the company. We compare both options before recommending one.

Advantages

  • No dilution of shareholders and no loss of control.
  • Flexible repayment: often at maturity, with interest paid or capitalised.
  • Gives access to deals that senior debt alone could not finance.
  • A participating loan strengthens equity for company law purposes.

What to weigh up

  • Higher cost than senior debt.
  • Usually requires an agreement with the senior bank.
  • May include a share of profits or rights over the equity.
  • Usually comes with reporting obligations and covenants.

CRITERIA

What the lender looks at

  1. Cash generation: whether the company or project can service both debt tranches.
  2. The full structure: how much senior debt ranks ahead and what equity the shareholders contribute.
  3. The business plan: expected growth, risks and scenarios.
  4. The team: the experience of those running the company or the project.
  5. The exit: how the tranche is repaid, through a refinancing, a sale or business cash flows.
  6. The relationship with the senior bank: the terms of the intercreditor agreement.

METHOD

How we work

  1. First conversation, free of charge. We look at the deal, the existing financing and what is missing.
  2. Structure design. We define how much can be senior debt, how much mezzanine and how much equity, and compare it with bringing in a partner.
  3. Information pack. Business plan, cash flow forecast and proposed structure, the way a lender asks for them.
  4. Presentation to selected lenders. Debt funds, family offices and institutions specialised in this tranche.
  5. Negotiation and closing. Terms of the tranche and coordination with the senior bank through to signing.

Fees: we work mainly on a success basis. Terms are agreed in writing before we start.

QUESTIONS

Frequently asked questions

What is the difference between mezzanine and subordinated debt?
Subordinated debt is any debt that is repaid after the senior debt. It is called mezzanine when, on top of interest, it carries an additional return linked to performance or to the equity.

Do I lose control of the company?
No. The lender does not take equity or vote at shareholder meetings, although it usually asks for regular reporting and compliance with certain covenants.

What is a participating loan?
A loan whose interest depends partly on the company’s results. Under Spanish company law (préstamo participativo) it is subordinated debt and counts as equity for the purposes of capital reduction and dissolution.

Do I need my bank’s consent?
Usually yes. Where there is bank debt, an intercreditor agreement is signed setting out who is repaid first and on what terms.

Is it used by real estate developers?
Yes. It is common to cover part of the equity required by the development loan.

How is it repaid?
It depends on the deal. Principal is often repaid at maturity, with interest paid periodically or rolled up until then.

Missing a tranche to close the financing and do not want a partner?

Tell us about the deal, the financing you already have and what is missing. We will tell you whether a mezzanine tranche fits or whether there is a better alternative. You can also call us on +34 678 131 989.

The information on this page is general and does not constitute an offer of finance or accounting or legal advice. Each deal is analysed individually and approval always depends on the lender.

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