Senior term loan vs Mezzanine finance
Senior debt sits at the top of the repayment queue and is priced accordingly. Mezzanine sits behind it, takes more risk and costs more, but it stretches the total amount you can raise without giving away ordinary equity.
| Criterion | Senior term loan | Mezzanine finance |
|---|---|---|
| Ranking | First, ahead of all other debt | Behind senior, ahead of equity |
| Cost | Lowest available debt pricing | Substantially higher, often part rolled up |
| Security | Full first ranking package | Second ranking, sometimes unsecured |
| Leverage supported | Conservative multiple of earnings | Extends total leverage beyond that |
| Equity element | None | Warrants or an equity kicker are usual |
| Covenants | Tight, tested regularly | Set with headroom below senior levels |
Senior debt is always the cheapest layer, so the sensible starting point is to establish the maximum a senior lender will provide against your earnings and security. Everything above that line is where the conversation about other capital begins.
The constraint is usually a leverage cap and a debt service cover requirement. Once those bite, more senior debt is simply unavailable at any price.
Mezzanine fills the gap between what senior lenders will fund and what the transaction requires, most often in acquisitions, management buyouts and step change expansion. Compared against issuing ordinary equity to close the same gap, it is frequently the cheaper option even at a double digit coupon.
The interest is often part cash and part rolled up, which protects cash flow in the early years while the investment matures. That structural flexibility is a large part of the value.
Where both layers exist, an intercreditor agreement governs payment priority, standstill periods and enforcement rights. Negotiate it properly, because it determines what happens in the one scenario nobody is planning for.
Also model the total burden honestly. Layering mezzanine over senior debt at full stretch leaves very little room for underperformance, and the combined obligations must be serviceable in a downside case, not just a plan case.
Use senior debt to its limit first. Add mezzanine only where a specific transaction needs more and the returns justify the cost, and only where the combined servicing works in a realistic downside.
Usually to a modest degree through warrants, far less than raising the equivalent amount as ordinary equity.
Providers typically engage from a few million upward, since the diligence cost does not scale down well.
Yes, and arranging them in parallel produces a cleaner intercreditor position than adding a layer later.
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