Discussions regarding debt and credit can be quite complex due to the industry jargon normally used. Subordinate debt and mezzanine debt are the perfect examples of this.
Mezzanine debt/fund is a form of subordinated debt where the borrowed funds can be converted into equity in case of default.
In contrast, the regular subordinate debt requires the borrowing company to pay an interest AND the principal. Mezzanine debt offers the lender equity interest in the company’s business. This can be in the form of stock warrants or bonus payments.
What’s Common between the Two Types of Debt?
The only thing common between mezzanine debt and subordinated debt is that both are considered subordinate to other loans. This plays a vital role in case the borrowing company declares bankruptcy or liquidation.Otherwise, this does not affect the payments themselves.
Understanding Mezzanine Debt
A mezzanine fund is a combination of debt and equity financing commonly used to expand established businesses rather than start-up companies. Mezzanine financing is the junior capital resource between senior debt (the less risky option) and equity (the high-risk option).
Understanding Subordinate Debt
Subordinate debt is any loan paid after all other corporate debts and loans, in case the borrower defaults. The usual applicants for subordinate debts are larger corporations or other significant business entities.
A mezzanine loan is one of the types of subordinated debt.
In case the borrowing company declares bankruptcy, the court prioritizes loan repayments using cash and assets. Loans such as senior debts and other unsubordinated debts will be paid first.
Whatever money remains after their payments will then be used to pay subordinate loans. This makes subordinate loans risky. This also requires the lenders to be mindful of the borrowing company’s solvency and other loan obligations.
Since mezzanine debt falls between subordinate and unsubordinated debts, it requires repayment in the form of cash and equity upon agreement. In case of the borrower’s default, the lender can recover a portion of its loan through the equity assigned in the contract. Moreover, they can use the cash after the high-priority loans are paid.
The Bottom Line
Even though a mezzanine loan is a form of subordinated debt, it has some characteristics of senior debt that make it less risky than regular subordinate debt. Since a mezzanine loan also requires equity as a source of repayment, the equity is often provided through a share in the company.
The lender must have the proper knowledge and experience to guide the borrower in financially challenging times. We recommend Global Capital Partners Fund for all commercial financing needs. With a wealth of experience, they have proven to be the best mezzanine finance provider in New York.
Visit their website for more information or speaking to one if their senior partners today!