What is a primary characteristic of mezzanine debt?

Mezzanine debt is a unique financial instrument that occupies a middle position in the capital structure of a company. This positioning is crucial because it effectively bridges the gap between senior debt, which has the highest claim and usually is backed by collateral, and equity, which has the lowest claim on assets and earnings.

The primary characteristic of mezzanine debt is that it sits between these two forms of financing. It typically carries a higher risk than senior debt because it is less secure; it often does not have the same collateral backing as senior debt and is thus subordinate to it. However, it is considered more secure than equity, as mezzanine debt holders have a claim on the company’s assets in the event of liquidation, but after senior debt holders have been paid.

This structuring often allows the issuer to raise capital without diluting existing equity shareholders. Mezzanine debt is also associated with higher interest rates than senior debt, reflecting its riskier nature, and may include equity-like features such as warrants or options, enhancing the potential return for investors.

Understanding mezzanine debt's positioning in the capital structure is vital for anyone analyzing alternative investments, as it highlights the balance between risk and return in financing strategies for businesses.