Key Insight
Mezzanine sits in the capital structure's most expensive neighborhood — it takes more risk than senior debt, so it demands higher returns. For buyers who can't fill a gap with equity or seller notes, mezz is an option, but the cost is real.
How Mezzanine Financing Works
Mezzanine lenders provide subordinated debt (sometimes convertible to equity) that fills the gap in a deal's capital structure:
Senior debt (e.g., SBA 7(a) loan) → funded first, lowest interest rate, secured by all assets Mezzanine → funded second, higher interest rate (12-20%+), may include equity kickers or warrants Equity → buyer's own capital, takes the most risk
A deal that needs $1M total capital might be structured:
- $750K SBA loan (75%)
- $150K mezzanine (15%)
- $100K buyer equity (10%)
When Mezz Appears in SMB Deals
True institutional mezzanine is more common in middle-market deals ($5M+). In SMB acquisitions under $5M, the structural equivalent is usually:
- Seller financing: The seller takes back a subordinated note — effectively acting as the mezzanine lender
- SBA 7(a) with seller standby: SBA requires a 10% equity injection; if the buyer is short, a seller standby note can fill the gap
The Cost Tradeoff
Mezzanine is expensive. At 15-20% interest, it dramatically affects DSCR and buyer returns. Every dollar of mezz is a dollar that doesn't come from equity (less dilution) but comes at a higher debt cost than senior financing.
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