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How does Mezzanine Debt Differ from Senior Debt in the Capital Stack?

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Mezzanine debt and senior debt differ primarily in their priority of repayment, risk profiles, and cost. In a capital stack, mezzanine debt acts as a hybrid bridge between senior debt and equity.

Key differences include:

  • Position and Priority: Senior debt holds the first claim on assets and cash flow. Mezzanine debt is subordinated, meaning it is only repaid after all senior obligations are satisfied but before equity holders receive value.
  • Risk and Return: Senior debt is considered low risk with typical returns of LIBOR + 200-400 bps. Mezzanine debt carries moderate-to-high risk, commanding a higher blended return of 10–20%. This return often consists of cash interest, payment-in-kind (PIK) accruals, and equity “kickers.”
  • Collateral and Covenants: Senior debt is usually secured by hard collateral and has the strictest financial covenants. Mezzanine debt is typically unsecured and relies on cash flow analysis rather than asset coverage, offering greater flexibility with fewer restrictive covenants.
  • Equity Participation: Unlike senior debt, mezzanine financing often include warrants or conversion rights. This allows lenders to participate in the company’s upside, similar to quasi-equity, without causing the immediate dilution associated with pure equity financing.

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