What is Mezzanine Finance and is It Right for Your Business?

Mezzanine finance sits between senior debt and equity in a company’s capital structure. It often fills the gap when traditional loans or equity investments don’t fully cover a business’s funding needs. This type of financing is popular for business growth, buyouts, or acquisitions because it offers flexible repayment without giving up ownership.

Contrary to conventional loans, this type of loan is not secured by company assets and ranks under secured debts in repayment priority. This is why it holds more risk for lenders and has a higher interest rate.

Hence, business owners should carefully assess whether it suits their growth goals and financial situation before using it. This guide covers what mezzanine finance is, how it compares to debt and equity, and its key pros and cons.

If your business plans to loan from an international lender or usually deals in overseas payments, you should check out Wise Business, an account that lets you get paid in 40+ currencies.

💡 Learn more about Wise Business

What is Mezzanine Financing? A Quick Overview

The word “mezzanine” comes from a Latin word meaning “middle,” which fits because this financing is a mix of debt and equity.

It’s often used when a business needs more money than a regular loan can offer or when banks see the loan as too risky. In return for taking on that risk, the lender can own part of the business if it can’t repay the money. This usually happens only after other lenders have been paid back.

While it’s more complicated than standard loans, mezzanine financing allows businesses to raise money for growth when other options fail.

Expected Rate of Return on Mezzanine Finances

Mezzanine financing typically offers higher returns than traditional loans because it involves greater risk. The interest rates usually fall between 10% and 20%, reflecting this elevated risk. Factors like the company’s financial health, overall market conditions, and the specific financing agreement terms all influence the rate.

Why Are Returns Higher?

Unlike secured loans, mezzanine financing is primarily unsecured, which means no collateral backs it. Because of this, investors demand a higher return, generally in the range of 12% to 20%, to compensate for the increased risk.

How Do Mezzanine Investors Earn Returns?

Returns can come from multiple sources. This enhances the appeal of this form of financing for experienced investors.

1. Cash Interest

Investors receive regular cash payments based on a fixed or variable interest rate tied to the loan amount.

1. Payment in Kind (PIK) Interest

Instead of cash, the interest is added to the principal and paid at the end of the loan period. For example, a £50 million loan with 10% PIK interest would grow to £55 million by the end of the loan term.

1. Equity Ownership

Mezzanine financing may come with equity upside, such as warrants or conversion rights. This allows investors to own a part of the business if it performs well.

1. Performance-Based Payouts

Instead of equity, some agreements offer a percentage of the company’s performance, like EBITDA or sales, as a return.

1. Arrangement Fee

Investors often receive a one-time fee when the deal is closed, which adds to their overall return.

Historical Performance

Despite being riskier, mezzanine financing has shown strong and consistent internal rates of return (IRR). Between 1998 and 2002, IRRs averaged 16% to 25%, never dipping below 15%, even during economic downturns like the 2008 financial crisis and the COVID-19 pandemic¹. However, actual returns can vary depending on company performance and default rates.

Example of Mezzanine Financing in a Real Business Scenario

Hometree is a UK home energy company. It raised £50 million in mezzanine debt from CPP Investments after securing £250 million in senior debt from Barclays².

Capital Structure Breakdown:

Funding Type	Amount	Role in Structure
Senior Debt	£250 million	Primary, secured debt with the highest repayment priority
Mezzanine Debt	£50 million	Subordinated debt sits between senior debt and equity
Equity	(Business ownership)	Residual value after debt obligations are met

The table illustrates that Hometree’s capital structure includes senior debt from Barclays as the primary, secured loan repaid first. The £50 million mezzanine finance sits in the middle. It is riskier and more expensive but offers lenders potential equity through features like conversion rights or warrants. Equity held by Hometree’s owners ranks last in repayment but retains full ownership unless mezzanine debt converts.

This structure helps Hometree raise extra funds through mezzanine debt without giving up ownership rights. In return, mezzanine lenders get higher returns and may gain a small stake in the company later. It’s a helpful way to support business growth while keeping control in the hands of the original owners.

Benefits of Mezzanine Financing

For Borrowers:

More Capital, Less Dilution

Mezzanine financing allows businesses to access more capital without giving up ownership too early. When a company needs more funds than a bank is willing to lend, mezzanine debt can fill that gap.

For example, if a business plans to raise £15 million but a bank offers only 75% of the loan amount, mezzanine financing can provide the missing piece. Banks often treat mezzanine as a form of equity. It makes them more confident in extending full loan amounts.

This approach reduces the need to raise large sums through equity, helping owners retain business control. Mezzanine debt is also tax-deductible and doesn’t require immediate principal repayment, which eases cash flow pressure.

Lower Cost of Capital

Equity is expensive and dilutes ownership. Mezzanine financing is a more cost-effective fundraising method. Just ensure it combines senior debt and a smaller equity portion. This blended structure can lower the total cost of capital while improving returns on equity.

For Investors:

Strong Returns with Growth Potential

Mezzanine debt appeals to investors because it usually offers high returns (between 12% and 20% per year). It also comes with fixed repayment terms and is paid back before equity. This element makes it a safer option than investing in shares alone.

Investors can earn returns differently, such as regular interest payments or Payment-in-Kind (PIK) interest, where costs are added to the loan and paid later. Some deals also allow investors to own part of the business if it does well. This means they can earn steady returns and benefit from the company’s future growth.

More Stability, Less Risk

Compared to equity, mezzanine debt is less affected by market changes. Repayments are agreed upon in advance and made before any payouts to shareholders. This gives investors more certainty and protects them from market ups and downs.

Before making a deal, mezzanine lenders carefully check the business’s track record and growth plan. This can lower the risk and ensure the money is being used wisely.

Looking at the bigger picture, mezzanine financing can give investors a good mix of strong returns, lower risk, and potential equity upside. It also supports a company’s continued growth.

Risks Associated with Mezzanine Financing

Mezzanine financing can be helpful, but it also comes with certain risks for the business:

• Costly Borrowing: Mezzanine loans have higher interest rates than traditional loans, making borrowing more expensive. This often puts pressure on the company’s profits and cash flow.
• Repayment Challenges: Even with flexible terms, repayment can become difficult. It’s more crucial if the business doesn’t perform as well as planned.
• Risk of Losing Ownership: If the company can’t keep up with payments, the lender may have the right to convert the debt into shares. This means the original owners could lose part of their control over the business.

Consider these risks before choosing mezzanine financing. Good planning and financial control can help manage them and keep the business on track.

Mezzanine Financing Readiness Checklist

Use this quick checklist to see if mezzanine financing aligns with your company’s needs and growth goals.

• You need more capital than traditional loans offer.
• You want to avoid giving up too much equity.
• Your business generates a steady cash flow.
• You’re comfortable with higher interest rates.
• You have a clear plan for expansion or acquisition.
• You’re open to some equity involvement by lenders.

If you checked most of these boxes, mezzanine financing could be a smart next step to push your business growth!

Receive international payments with Wise Business

Wise can help UK businesses to get paid by investors and partners in multiple currencies, with low fees and the mid-market exchange rate.

Your Wise Business account comes with local account details to get paid in 8+ major foreign currencies like Euros and US Dollars just as easily as you do in Pounds.

All you need to do is pass these account details to your partners and they can make a local payment in their preferred currency. You can also use the Wise request payment feature to make it even easier and quicker for customers to pay you.

Get started with Wise Business 🚀

FAQs – Mezzanine Financing

What is the return on mezzanine debt?

Mezzanine debt usually gives higher returns than most other types of loans. Investors earn between 12% and 20% a year, and even up to 40% in high-risk deals.

Is mezzanine financing expensive?

Yes, mezzanine financing costs more than senior debt but less than equity. Since it combines both features, the price usually falls somewhere in between.

How is mezzanine financing structured?

Mezzanine financing is between senior debt and common equity in a company’s capital structure. It’s usually unsecured subordinated debt, but it can include preferred equity or a mix of both.

---

Mezzanine financing has grown from a niche product in the 1980s to a widely used investment tool, attracting pension funds, hedge funds, LPs, and banks. Traditional mezzanine lenders focus on long-term, cash-flow-based lending with equity participation. It brings them more stability than volatile markets like equities or high-yield bonds.

Despite geopolitical and economic headwinds in the UK, the mezzanine debt market remains resilient. Deals like Hometree show continued investor confidence. And even globally, demand for mezzanine debt is rising due to its strong returns, lower volatility, and strategic flexibility. These factors make it a valuable part of modern capital structures.

Sources:

1. Mezzanine Finance
2. Energy services startup Hometree raises £50M mezzanine facility to lead UK home decarbonisation

Sources last checked 23/09/2025