What Is Mezzanine Finance?
Mezzanine finance refers to securities that are classified between stocks and bonds. They are often used in leveraged buyouts and rapid business expansion. Those who might get involved in this investment area will be interested in the origin of this term, three types of mezzanine securities, why mezzanine finance is used, the classification of these instruments and the benefits and risks of using mezzanine finance.
Other People Are Reading
-
Mezzanines in Buildings
-
The word mezzanine refers to a platform between floors in a building. Mezzanines are often found in luxury hotels, casinos and opera houses. They often overlook the first floor of a building, providing a great view. A balcony can be an example of a mezzanine. Similarly, mezzanine finance involves the issue of securities that have a classification between debt and equity.
Types of Mezzanine Securities
-
Mezzanine finance includes three types of securities: senior subordinated debt, convertible subordinated debt and redeemable preferred stock. Senior subordinated debt has the highest priority for repayment in bankruptcy. Convertible subordinated debt has a lower priority, but it can be converted into preferred stock. Redeemable preferred stock has an even lower priority and can be transferred back to the company for cash. All of these instruments have a priority in bankruptcy subordinate to other bonds and greater than common stock. A convertible bond is one type of convertible subordinated debt.
-
Leveraged Buyouts
-
Mezzanine finance is often used in leveraged buyouts. In a leveraged buyout, a company borrows money to purchase the equity shares of another company. The purchasing company would normally have to borrow at high rates because of the size of the loan, and equity investors may also be skeptical, so the company issues securities such as convertible bonds to provide funding for the purchase.
Benefits
-
The benefit of mezzanine finance is that it bridges the gap between debt and equity financing. The equity component of these securities reduces the ratio of debt that the company reports. Mezzanine finance also offers flexibility to investors, as they can convert their holdings from stocks to bonds or vice versa without being forced to sell them in the market and paying spreads and other fees.
Risks
-
Mezzanine finance also involves risk. The company using mezzanine finance may have already borrowed as much as the banks believe is safe to lend to it. The mezzanine investor provides additional money at this point, without sharing as much potential gain as a common stockholder.
-
References
- Photo Credit ornate balcony image by John Sfondilias from Fotolia.com
