What is Mezzanine Financing?

Mezzanine financing is a popular route for funding real estate development, management buy-outs, and major corporate transactions, like acquisitions and business expansions. To many, it can sound rather complex, but it doesn’t have to be. Mezzanine financing, also known as subordinated debt, is a highly effective growth-finance solution.

In this blog, we’ll break down exactly how mezzanine financing works, when it can be the right choice, the benefits it delivers, and what to watch out for. 

The Meaning of Mezzanine Financing 

Mezzanine financing is a hybrid form of business funding that combines features of both debt and equity. It slots between senior debt and common equity in a company’s capital structure. In a liquidation scenario, it is repaid after senior debt, such as bank loans, but before equity holders.

Because it carries a higher risk than senior secured debt, mezzanine financing typically comes with higher interest rates and may include equity-like features, such as warrants, that give the lender a share in the business’s future upside. It may also provide conversion rights into equity under certain conditions.

In practice, mezzanine financing is often used to “fill the gap” when traditional loans alone aren’t enough. For example, it’s used in acquisitions, management buy-outs (MBOs), or major growth projects.

Mezzanine Financing Example

To better illustrate how mezzanine financing works, let’s look at a simple example of how it might be used in practice by examining a completely hypothetical scenario.

Let’s say there is a company; let’s call it Company 1. It’s an established business and now wants to acquire a smaller rival for £5 million.

• It contributes £2 million of its own capital.
• A bank provides £2 million in senior debt.
• That leaves a £1 million funding gap.

Company 1 doesn’t want to issue new shares or bring in outside investors; it wants to retain full ownership and control.

This is where mezzanine financing comes in. Company 1 could approach a private credit provider such as Growth Lending to provide the remaining £1 million as a mezzanine loan.

Because the loan is higher risk for the lender, it might carry something like a 12% interest rate, plus a 2% equity kicker should the company sell or float within five years. Meanwhile, the bank loan might have a lower rate, let’s say 7%.

The benefit? Company 1 closes the acquisition promptly, retains control, and avoids diluting ownership, while the mezzanine lender is compensated for its higher risk with a stronger return. In the end, it’s a win-win for all parties. 

Why Use Mezzanine Financing?

There are many benefits to using mezzanine financing, some of which are:

Bridge Funding Gaps

As mentioned previously, when senior debt isn’t enough and issuing equity isn’t desired, mezzanine finance bridges the gap between traditional loans and owner or investor equity.

Access To More Capital

Mezzanine loans make larger transactions possible, such as acquisitions or major expansions, because they increase the total funds available beyond senior debt limits.

Can Improve Balance Sheet

Mezzanine financing can help with the balance sheet. This is because it can be shown as equity on the balance sheet, which can lower reported debt levels and make the company appear healthier to other lenders. 

Flexible Repayment 

Mezzanine can be a lot more flexible than standard debt, making it a much more variable option for those seeking a flexible repayment plan. With options like deferring principal payments and rolling up interest payments into the loan balance, it can help manage cash flow during growth phases. 

Reduced Equity Dilution

As mezzanine financing is structured as a hybrid of debt and equity, the company only gives up ownership stake if it fails to repay the loan. This preserves ownership for existing shareholders. 

Diversification of Finance

Using mezzanine finance allows a business to broaden its funding sources, reducing reliance on a single lender or investor. This diversification can help strengthen financial resilience and provide greater flexibility in future growth plans.

Cheaper Than Equity Financing

Because mezzanine finance combines elements of debt and equity, business owners can access growth capital without giving up ownership, unless the loan cannot be repaid. In most cases, lenders take a hands-off approach, exerting little influence over day-to-day operations beyond the agreed loan terms.

Who Uses Mezzanine Financing? 

Mezzanine financing is most commonly used by established, profitable businesses with strong cash flow and clear growth ambitions. These companies have often reached the limit of what traditional banks will lend, but still need additional capital to fund acquisitions, management buyouts, or expansion projects without giving up ownership or control.

It’s also a popular option among real estate developers and mid-market firms that want to bridge the gap between senior debt and equity investment. In short, mezzanine finance suits organisations that are financially stable, growth-focused, and looking for a flexible way to scale.

What Is Mezzanine Financing in Real Estate?

In real estate, mezzanine financing is used to fund acquisitions, developments, or major refurbishments when banks won’t provide full conventional lending. It sits between senior debt and equity, repaid after bank loans but before investor equity.

Developers use it to raise additional capital without issuing fresh equity and reducing ownership. From the lender’s perspective, it offers higher returns and often a small equity stake or other upside if the project succeeds.

Are Mezzanine Loans Secured?

Mezzanine debt can be either secured or unsecured. Frequently, the lender takes a charge over the borrower’s ownership interest in the company rather than traditional asset collateral, since the company’s assets may already be tied up in senior debt. This characteristic, combined with its position in the repayment hierarchy, means mezzanine financing often carries a higher cost and risk.

Limitations of Mezzanine Financing 

Having said all of this, there can be some drawbacks to mezzanine financing. Some of the trade-offs include:

Higher costs

Mezzanine loans can be significantly more expensive than senior loans, with interest rates ranging from 10% to even 35%.

Higher Financial Risk

As mezzanine debt exhibits increased financial risk, there is a greater emphasis on gains in order to cover repayment obligations. 

There Is A Risk of a Default

As a subordinate to senior debt, there is always a risk of default. 

Loss of Control

If a business fails to meet its obligations, the mezzanine lender can convert their loan into an equity stake, which could result in a new, unexpected partner. 

Equity Dilution

Warrants or share options can be included in the mezzanine loan, which can be converted into equity, giving them a small ownership stake if certain conditions are met. This can slightly dilute existing shareholders’ ownership and profits and, in some cases, reduce overall control of the business.

Lengthier Process and Complexity

Agreements typically involve guarantees, covenants, and profit-sharing clauses, making them more complex to negotiate and manage than standard loans.

Is Mezzanine Financing Right For You? 

If you are looking at your next growth project and are wondering if mezzanine finance is right for you, we hope this blog has showcased that mezzanine finance is a very valuable avenue to accelerate business growth. 

At Growth Lending, we specialise in delivering flexible finance solutions that align with your ambition, whether for growth loans, acquisition finance or mezzanine-style funding. Contact our team to explore how we can support your next move. Also, be sure to stay up to date with our knowledge bank for more valuable industry insights.