Mezzanine finance is typically employed in the expansion phase of a company and therefore belongs to the broader category of later-stage financings. This is because the prerequisites for a company to get mezzanine finance are strong, sustainable and predictable future cashflows, a strong market position with an established portfolio of products, a good track-record of the management, and a high financial stake of top management in the company.
Mezzanine finance is a mixture between pure debt and equity financing with a long, but fixed time horizon. Private investors are compensated through a predetermined fixed interest rate, the debt component, which is usually lower than for pure debt, and a performance-related component, often in the form of so-called equity kickers that drives the expected return rate of the investment.
The debt component of mezzanine finance is typically subordinated to existing pure debt and therefore participates like equity in occurring losses. Legally mezzanine finance is treated like debt on the balance sheet, but economically it shows characteristics of equity and therefore it is often also called quasi equity.
Mezzanine finance lies at the end of the private equity spectrum and comes into play when the company has no or no sufficient access to external debt (banks or corporate debt) or equity (stock) markets, but nevertheless a strong upside potential.
The biggest advantage of mezzanine finance lies in the almost unlimited flexibility of this instrument such that the structure of the deal can be well adapted to the financing needs of the company.
For example, things to be agreed upon are the interest rate, the contract size, the maturity, the call ability, the inclusion of equity kickers or other performance related components avoiding dilution effects, the role of collateral, the extent of covenants regarding information rights and duties, etc.