Mezzanine Debt Financing: How It Works and When to Use It

Mezzanine debt financing is a loan that ranks below senior debt and above equity in a company's capital structure. It costs more than senior debt, and it fills a gap when a borrower cannot raise enough money from a bank or asset-based lender alone. Borrowers use it mainly for acquisitions, growth, and recapitalizations. Lenders accept the higher risk in exchange for higher returns.

Thrive Funding arranges mezzanine and other private credit for middle-market companies. Thrive is not the lender. The lending group makes the credit decision, and Thrive is paid by its lending partners.

What mezzanine debt is

Mezzanine debt is a hybrid. It behaves like debt because it carries interest and a repayment schedule. It also carries equity-like features that give the lender more upside. According to Carta, mezzanine debt is a hybrid financing solution positioned between senior debt and equity, offering growth capital with flexible terms.

The layers work like this. Senior debt is repaid first and is usually secured by the company's assets. Mezzanine debt is repaid after senior debt. Equity holders are paid last. Because mezzanine lenders are paid after senior lenders, they price their loans higher.

How the capital stack creates a gap

The most common reason to use mezzanine debt is a funding gap. A senior lender limits how much it will lend against a deal. The borrower covers the rest with equity. If the equity is not large enough, a gap remains.

Real estate makes this easy to see. According to Origin Investments, a senior lender might only be willing to finance 60% to 65% of a property's total cost today. If a sponsor has only 15% of the cost in equity, a 20% funding gap is left. A mezzanine lender steps in to provide that missing 20%.

The same logic applies to operating companies. A business buying a competitor or funding expansion may find that senior lenders cap their loan. Mezzanine debt can fill part of the difference without forcing the owners to give up as much equity.

What mezzanine debt costs

Mezzanine debt is priced above senior debt, because the lender is paid second. According to Carta, mezzanine debt is more expensive than senior debt, and a typical loan to a performing company is expected to yield 12.5% to 14% for the lender.

Origin Investments gives a real estate example. It describes a private credit fund providing a $15 million mezzanine loan at an interest rate of 10% to 12% (Origin Investments). The rate depends on the deal, the risk, and the market.

Most mezzanine deals combine several cost elements:

• Cash interest paid on a regular schedule
• Payment-in-kind (PIK) interest that accrues to the loan balance instead of being paid in cash
• Fees paid at closing
• Equity features such as warrants or a right to convert debt into equity

Each element changes the true cost. A loan with a lower cash rate but large warrants can cost more than it first appears. Compare the full package, not only the headline rate.

Mezzanine debt compared with other capital

Feature	Senior debt	Mezzanine debt	Common equity
Repayment priority	First	After senior debt	Last
Typical cost to borrower	Lowest	Higher than senior debt	Highest in expected return, no fixed payments
Security	Usually secured by assets	Often unsecured or second-lien	None
Ownership dilution	None	Usually none, unless equity features are included	Yes
Main use	Core borrowing base	Filling the gap above senior debt	Final layer of funding

The table shows general patterns. Actual terms vary by lender and deal.

When mezzanine debt makes sense

Mezzanine debt fits best when a company has steady cash flow, can cover the interest, and wants to avoid giving up a large share of ownership. It is also common when a business needs to close a deal quickly and cannot wait to raise more equity.

Some investors target middle-market companies already generating revenue. According to Carta, those investors typically look at companies with revenue between $2 million and $20 million, though every situation is different.

It is a poor fit when cash flow is unpredictable and the company cannot service the interest. Mezzanine debt adds a fixed cost to the business. A lender that cannot be repaid can use its equity features to take a larger stake, so owners should model the downside before signing.

Risks to weigh

The main risks are cost, cash-flow strain, and loss of control. The interest and fees reduce the cash available for operations. Equity features can dilute owners if the business performs well. Covenants can limit what management can do without the lender's approval.

Owners should also check what happens in default. Some mezzanine agreements let the lender convert debt into equity or take control of the company. Read those terms before agreeing to the loan.

How to get mezzanine financing through Thrive Funding

Thrive Funding works with middle-market borrowers seeking loans from $1 million to more than $100 million. Requests under $1 million receive an automatic decline, because the lending groups in its network do not fund them.

The process runs in five steps:

1. The borrower submits an application at thrivefunding.com/apply.
2. Thrive matches the application against each lending group's criteria, including deal size, revenue and EBITDA minimums, industries, states, loan types, and pricing.
3. Matching groups receive an anonymous deal summary and reply yes or no on whether the deal fits.
4. Once the borrower agrees, up to three groups that said yes receive introductions, best fit first. Each introduction is a separate email thread, so the groups do not see each other.
5. Lenders issue term sheets on their own letterhead. Thrive sends the borrower a side-by-side summary, and the borrower chooses one. The success fee is owed only when the loan closes.

Any figures shared before a term sheet are indicative terms. They are not a term sheet and not an offer. Deals are matched by fit, not by payment. A lending group that pays for access to the network does not gain priority over others.

Questions to ask any mezzanine lender

Before you accept a term sheet, ask each lender the following:

• What is the all-in cost, including cash interest, PIK interest, fees, and the value of any equity features?
• What are the covenants, and what happens if a covenant is breached?
• How is the loan repaid, and is there a prepayment penalty?
• What happens in default, including any right to convert debt into equity?
• How does the loan sit against senior debt, and what intercreditor terms apply?

Sources

• Mezzanine Debt: What it is and when to use it
• What Is Mezzanine Debt & Why It Matters for Investors
• Thrive Funding application