Mezzanine debt is a hybrid form of financing which has features of both debt and equity, and is subordinate to all other types of debt. It is called “Mezzanine” because it sits between senior debt holders and and equity holders in terms of claims on assets in the event of bankruptcy. It also sits between senior debt and equity in terms of risk and return potential, and is therefore a cheaper form of capital than equity, but more expensive than senior debt.
Mezzanine debt is a hybrid security, because in addition to the interest payments that mezzanine debt holders receive, they also get the potential to own a piece of the business. This often comes in the form of an equity warrant, which allows the mezzanine debt holder to purchase equity in the company at a fixed price before a specified expiration date.
Because it is more expensive than other forms of debt Mezzanine debt is often used to cover a funding gap which is needed in order to acquire a company or buy out an existing shareholder or shareholders.
For more definitions and explanations please visit the Learn Bonds glossary where we give the meaning of many additional bond terms.