Mezzanine debt, also known as mezzanine financing. In a leveraged buyout situation, mezzanine finance will be used to bridge the gap between the amount advanced by senior lender(s) and investment made by private equity firm(s).
It is structured as a loan, but it also contains equity-like characteristics, such as warrants or options to acquire equity in the company. Mezzanine debt holders rank below senior debt holders but above equity holders in terms of repayment priority in the event of a default or liquidation. Nowadays, mezzanine debt is usually secured.
The principal amount of mezzanine debt would only be repaid after all the senior debt has been repaid in full. To compensate for the increased risk of not being repaid, mezzanine lenders require a higher rate of return (in the form of higher interest rates and an equity stake).
Who are the Players
Mezzanine finance is usually provided by specialist mezzanine providers, funds specifically set up to invest in products such as mezzanine finance, and financial institutions.
In a mezzanine transaction, the main documents would involve the following:
- Mezzanine facility agreement
- Inter-creditor agreement
- Security package
Mezzanine facility agreement
The terms of the mezzanine facility agreement will usually mirror those of the senior facilities agreement. This is to ensure that the senior lender(s) will have priority over mezzanine lender(s).
Some of the key differences between mezzanine facilities agreement and a senior facilities agreement:
The tenor of a mezzanine facility is usually longer than senior facilities.
Prepayments will only be allowed after senior facilities have been fully repaid.
Mezzanine facility is usually lent in a single currency and with the drawdown to be made at completion. This is slightly different from senior debt, where the facility would be made available in various tranches.
Interest payment dates for mezzanine facility would usually be fixed with reference to the reference dates of the various financial covenants contained in the senior facilities agreement, as well as the borrower’s cashflow. This would provide some buffer to the borrower or the target group in meeting the financial covenants.
In addition to interest payments, mezzanine lenders may (1) have an interest in the equity of the borrower and/or the target group (in the form of warrants); and (2) fees for early repayment, in the event that the borrower repaid the mezzanine facility in full prior to its maturity.
Generally speaking, the financial covenants in a mezzanine debt is less stringent than a senior debt; and if an event of default is triggered under the senior facilities agreement, it would not automatically trigger a cross default under the mezzanine facility. The purposes for the mezzanine facility to have less stringent requirements than senior lender is to allow the senior lender to resolve the matter with the borrower without any interference from the mezzanine lenders.
Subordination – the ranking of debts can be achieved by:
- Structural subordination – where senior debts are lent to companies that have most of the assets; and
- Inter-creditor agreement – this would regulate the relationship between lenders. The intercreditor agreement would set out an order of payments, in especially in the event that the borrower breaches the terms of the facilities agreement(s), security would need to be enforced.
How we can help
If you would like to find out more about the contents in this note or other issues pertaining to mezzanine financing, such as enforcement rights, drag-along rights, terms of warrants usually issued to mezzanine lender(s), security, and advantages and disadvantages of mezzanine finance, please contact us.
Alfred Leung, Partner
(E: firstname.lastname@example.org; T: +852 3468 7202)
YTL LLP is a law firm headquartered in Hong Kong, China. This article is general in nature is not intended to constitute legal advice.