MEZZANINE

In the diverse world of business financing, relying solely on traditional forms like venture capital and bank loans can be limiting. For steward-owned companies, for which traditional equity financing is not an option, or for companies that are not bankable, exploring alternative financing methods can be beneficial. One such alternative is mezzanine capital.

Mezzanine capital is an adaptation of traditional capital models to better suit the needs of entrepreneurs by blending equity and debt. Mezzanine financing takes parts of equity (flexibility and patience) through structured exit agreements and combines it with parts of debt (self-liquidation). Within mezzanine capital, there is a broad range of instruments that can be flexibly combined and adapted, and depending on how they’re structured, they can lean more toward debt or more toward equity. 

Debt-like mezzanine capital resembles traditional debt in aspects like fixed interest payments and repayment schedules but is subordinated to senior debt in the repayment hierarchy. It may offer deferred or flexible payment terms to match the company’s cash flow. While it sometimes includes variable payments linked to performance and may grant investors more extensive rights than standard debt – such as information, consultation, or veto rights (see Deep Dive Governance for more) – it still differs from equity or equity-like mezzanine capital in its chance and risk level (profit and loss participation) and patience. 

In contrast, equity-like mezzanine capital moves closer to equity investment as it offers greater opportunities to account for the uncertainty of the company’s development in the long-term and thus model the investor’s upside more accurately. For this reason, it is often used in startup, early-stage, or growth financing. It typically involves some form of profit or revenue sharing and may include options or warrants that allow conversion into (non-voting) equity shares under certain conditions. In certain instances, equity-like mezzanine capital might even be interesting for investors with more long-term objectives, such as Evergreen investors. When companies opt for participatory financing, they must carefully determine how investors will be involved in the financial gains (and potentially also the losses) of the business.

The opportunities and risks associated with mezzanine financing are generally higher than those of debt financing but lower than those of equity financing. This means that mezzanine financing occupies a middle ground in terms of risk and opportunities (and thus also costs) between senior debt and equity. While many of these instruments may still be relatively new in the startup world, they are already widely used in more mature small and medium-sized companies.