Mezzanine debt is a loan with low credit priority on a company’s assets, resulting in higher costs for lenders. It can be provided through subordinated debt or preferred stock, but is risky and often demands higher returns. Specialist lenders offer mezzanine investment funds.
Mezzanine debt is a type of loan from a public company in which the lender has a particularly low credit on the company’s assets in case it goes into liquidation before the debt is paid. In this situation, the lender’s claim will be ranked lower than all other creditors except common stockholders. As a result, this type of debt tends to incur higher costs for the lender than other types of loans.
The phrase mezzanine debt simply refers to the lender’s low credit priority over assets and can cover two different ways in which lending works. One is like a subordinated debt. This means that an existing lender lends more money to the borrower, with the specific understanding that this new debt is subordinated, meaning that he does not have the same claim on the assets.
The second major way to provide mezzanine debt is through preferred stock. This differs from common stock in that its holders have a greater claim to the assets and priority in receiving any dividend payments. In the event of a liquidation, holders of preferred stock will be entitled to receive the par value of their shares, assuming the money is left for them. Only once all holders of preferred stock receive this payment from the liquidation will ordinary shareholders be entitled to their money back.
In reality, most people who lend money in a form classified as mezzanine debt will often receive cash if the company goes into liquidation. This is because the debts that have forced liquidation will usually be so high that all assets will be eaten up by claims of other creditors who have a higher priority claim. Because of this higher risk, mezzanine debt lenders usually demand a higher return. This would be through higher interest payments on subordinated debt or higher dividend payments on preferred stock. There will often be a settlement fee attached to mezzanine debt.
Because mezzanine debt has such distinctive characteristics, it is often provided by specialist lenders. Some of these offer mezzanine investment funds. These are inherently riskier but with a higher potential return than many other types of investment funds. In many cases, a mezzanine debt will be built so that all interest payments are held until the principal of the loan is repaid. This can be useful for businesses that borrow in this way, especially those who are borrowing to ease liquidity problems.
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