Explain the use of mezzanine debt in LBOs?

Mezzanine debt (or commonly referred to as Mezz) is a hybrid security which can be structured to allow the holder to earn higher returns based on equity or warrants. Typically, Mezz allows the holder to earn interest income but also allows them an option to convert the instrument into equities later. in case where the investee companies are successful.

Mezzanine debt is an interim layer of capital that sits somewhere between equity and debt capital in an LBO. Mezz is a funding product which is tailored to the requirements of the borrower and the investor based on the specific deal and return profiles. It is typically used by the PE funds as it comes at a lower cost of capital than that of equity investments, also helping reduce the total equity investment in the deal. It can also be used to replace or complement high yield debt when the market to raise high yield debt is not conducive.

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