Alex is Sprintlaw's co-founder and principal lawyer. Alex previously worked at a top-tier firm as a lawyer specialising in technology and media contracts, and founded a digital agency which he sold in 2015.
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If you’re running a growing startup or SME, there’s a point where bootstrapping stops being the sensible option.
You might need to hire key people, invest in product development, open a second location, buy equipment, or even acquire a competitor. And while raising equity can be exciting, it can also feel like you’re giving away too much of your business too early.
That’s where mezzanine debt often comes into the conversation.
Mezzanine funding can be a powerful tool for growth, but it’s also one of the more complex finance options in the market - both commercially and legally. In this guide, we’ll break down what mezzanine debt is, when it makes sense, what to watch out for, and what legal documents you’ll typically need in place before you sign anything.
What Is Mezzanine Debt (And Why Do Businesses Use It)?
Mezzanine debt is a type of funding that sits “in the middle” (or mezzanine) between senior debt (like a bank loan) and equity (selling shares in your company).
It’s usually used by businesses that:
- are already trading and generating revenue (often with predictable cashflow),
- want to grow quickly (or fund an acquisition), and
- don’t want to dilute ownership as much as a full equity raise would.
In simple terms, mezzanine debt is a loan with a higher risk profile than a traditional bank loan, so it often comes with:
- higher interest rates,
- fees, and/or
- an “equity upside” for the lender (for example, share options or warrants).
Where Does Mezzanine Debt Sit In The Capital Stack?
If your business ever becomes insolvent, different funders are repaid in a particular order (often referred to as the “capital stack”). Mezzanine debt generally ranks:
- behind senior secured lenders (like banks with security), but
- ahead of shareholders (equity holders).
This ranking is a big part of why mezzanine funding costs more than senior debt: the lender is taking more risk.
Is Mezzanine Debt “Debt Or Equity”?
Mezzanine finance is typically structured as debt, but it may include equity-like features. For example, the lender might receive:
- a right to convert some of the loan into shares in certain scenarios,
- warrants/options to buy shares at a set price, or
- an arrangement where repayment depends partly on performance.
Because of this hybrid nature, it’s important to treat mezzanine debt as both a finance decision and a legal/risk decision for the long term.
When Does Mezzanine Debt Make Sense For UK Startups And SMEs?
Mezzanine debt isn’t usually the first funding option a business uses. It tends to appear once you’ve already built traction and need capital to scale.
Common scenarios where mezzanine debt may be on the table include:
1) Funding A Growth Push Without Heavy Dilution
If you’ve already raised equity (or you’ve got a clear view of your company’s future value), you might prefer to avoid selling shares at today’s valuation.
Mezzanine debt can let you access larger funding amounts while keeping more ownership in your hands - though lenders may still ask for equity “kickers” as part of the deal.
2) Bridging A Gap Before A Major Liquidity Event
Some businesses use mezzanine finance as a bridge to:
- a future equity round,
- a refinancing, or
- a sale (partial or full exit).
The idea is that you can execute a growth plan now, then repay (or refinance) later when the business has grown.
3) Supporting An Acquisition Or Management Buyout
Mezzanine debt is often used in acquisition structures because it can top up the funding mix between senior debt and equity.
If you’re buying another business (or assets), you’ll also want to think carefully about what happens if contracts need to move to a new entity. A Deed of Novation can be relevant where agreements can’t simply be assigned and need to be transferred with the other party’s consent.
4) You Have Strong Cashflow But Limited Security
Traditional lenders may want strong security and strict affordability checks. Mezzanine lenders tend to focus more on:
- business performance and projected cashflows,
- the strength of the management team, and
- the strategic plan for growth.
That said, mezzanine lenders can still ask for security - sometimes second-ranking security behind a bank.
Key Commercial Terms In Mezzanine Debt (What You’ll Negotiate)
Mezzanine debt documents can look intimidating because there are more moving parts than a standard loan. Here are the key terms you’ll usually see, and why they matter.
Interest Rate (Cash Pay Vs Payment-In-Kind)
Mezzanine finance often includes a higher interest rate than senior debt, and it may be structured as:
- cash-pay interest (paid monthly/quarterly),
- PIK interest (payment-in-kind, added to the loan balance), or
- a combination of both.
PIK structures can help with short-term cashflow, but they also mean your balance grows over time - so you’ll want to model the repayment carefully.
Term Length And Repayment Profile
Mezzanine loans often have medium-term maturities (for example, 3–7 years), and repayment may be:
- interest-only with a “bullet” repayment at the end, or
- partly amortising (repaying some principal along the way).
Covenants And Information Rights
You can expect more controls than you’d usually see with informal lending. Covenants may include:
- financial covenants (such as leverage ratios or EBITDA targets),
- restrictions on taking on more debt,
- limits on distributions/dividends, and
- regular reporting requirements (management accounts, budgets, forecasts).
These controls aren’t automatically “bad” - but they do affect how freely you can run your business day-to-day.
Fees, Exit Premiums, And “Equity Kickers”
Mezzanine lenders often use fees to balance the risk/return profile, such as:
- arrangement fees,
- monitoring fees,
- early repayment fees, and
- an exit fee or premium payable on repayment.
In some cases, the lender may also require an equity component (such as warrants). If you’re granting any form of rights over shares, it’s essential your cap table and governance documents can handle it - this is where a properly drafted Shareholders Agreement is often important.
Events Of Default
Events of default set out when the lender can take enforcement action (or demand repayment). They commonly include:
- missed payments,
- breach of covenants,
- insolvency-related triggers,
- cross-default (a default under another finance agreement), and
- misrepresentation or fraud.
The wording here matters a lot, because it can impact whether a “small slip” becomes a major finance crisis.
What Legal Documents Do You Typically Need For Mezzanine Debt?
This is the part founders often underestimate: mezzanine debt is not just “a loan agreement and done”.
Because it sits between debt and equity, the documentation can involve a package of agreements - especially if you already have bank finance or other investors.
The Core Finance Agreement
This is typically the main loan document setting out the amount, repayment, covenants, default terms, and lender rights.
Even if you start from a precedent, the agreement should be tailored to your specific structure, assets, and growth plan. If you’re comparing options, it can help to understand the building blocks of a solid loan contract (including what you should never leave vague) - many businesses start with a framework like these Loan Agreement templates and then properly customise from there.
Security Documents (If Required)
Mezzanine lenders may ask for security, often second-ranking behind a senior lender. Security can include:
- charges over assets (fixed or floating),
- security over shares, and/or
- guarantees (for example, from a group company).
If your business is part of a group structure, it’s also important to check whether intra-group arrangements exist (and whether they need to be documented cleanly).
Intercreditor Agreement (If You Have A Senior Lender)
If there’s a bank or senior lender in the picture, mezzanine finance commonly requires an intercreditor agreement.
This sets out how lenders interact, including:
- who gets paid first (priority),
- what happens in enforcement,
- standstill periods (where mezzanine lenders agree not to enforce for a period), and
- how amendments/waivers are handled.
This document is a big deal. You don’t want to accidentally agree to restrictions that make it impossible to refinance later or run your business smoothly.
Equity Documents (If There’s A Conversion Or Warrant Element)
Where mezzanine debt includes conversion rights, options, or warrants, you’ll need to make sure the equity side is legally consistent with your company’s constitution and existing investor rights.
Depending on the structure, you may need:
- board and shareholder approvals,
- updated articles, and/or
- fresh equity documentation, such as a Share Subscription Agreement.
If you’re negotiating broader fundraising terms at the same time (for example, pre-agreed terms for a future round), it’s common to document the commercial deal first in a Term Sheet before the long-form agreements are finalised.
Company Approvals And Director Duties
Directors need to be comfortable that taking on mezzanine debt is in the company’s best interests, and that the company can realistically meet repayment obligations.
If the business is under financial pressure, directors should be especially cautious. Decisions around new debt can have serious implications if there’s later an insolvency scenario.
This is one of those areas where getting tailored legal advice early can save you a lot of pain later - especially if the lender is asking for personal guarantees or aggressive default triggers.
Mezzanine Debt Vs Other Funding Options (What Should You Compare It Against?)
Mezzanine debt isn’t “better” or “worse” than other funding - it’s about fit.
When you’re weighing it up, it helps to compare it to the options most UK startups and SMEs consider:
Senior Debt (Bank Lending)
- Pros: Usually cheaper, clearer repayment terms, often more familiar to founders.
- Cons: Tighter lending criteria, strong security requirements, stricter covenants, lower flexibility.
If you can get senior debt on good terms, it’s often the first place to start. Mezzanine debt tends to be a “top-up” or alternative where senior debt alone won’t cover the capital need.
Equity Finance
- Pros: No scheduled repayments, investor alignment with growth, can bring strategic support.
- Cons: Dilution of ownership, governance controls, longer negotiation cycles.
If you’re raising equity, make sure your internal governance is solid. A well-structured Shareholders Agreement can reduce confusion around control, decision-making, and exits once new stakeholders are involved.
Convertible Notes And Other Hybrid Instruments
Some businesses consider a convertible instrument as an alternative to mezzanine, especially earlier in the growth journey.
A Convertible Note is commonly used in startup funding because it postpones valuation discussions and converts later (usually in a priced round). It’s not the same as mezzanine debt, but it’s another hybrid tool worth comparing if you’re not yet at the “cashflow supports debt service” stage.
Shareholder Or Director Loans
In SMEs, funding sometimes comes from within - directors, founders, or existing shareholders lend money to the business.
This can be simpler and cheaper than mezzanine funding, but it still needs to be documented properly to avoid disputes, tax confusion, or repayment issues later. If this is relevant to you, it’s worth understanding the basics of Shareholder loans and how they should be recorded.
Key Risks With Mezzanine Debt (And How To Protect Your Business)
Mezzanine debt can accelerate growth - but it can also create pressure if the business doesn’t hit forecasts.
Here are some common risk areas we see for SMEs considering mezzanine funding, and how to manage them.
Cashflow Stress From Higher Cost Of Capital
Because mezzanine finance is more expensive than senior debt, repayments (or PIK accruals) can add up quickly.
Practical tip: model conservative scenarios (not just your “best case”), and check you still have headroom if sales drop, costs increase, or an expansion takes longer than expected.
Covenants That Limit Flexibility
Even when you’re not in default, restrictive covenants can limit what you can do - like hiring, taking on new leases, entering major contracts, or raising additional money.
Practical tip: negotiate realistic covenant levels and clear carve-outs for normal business operations and growth initiatives.
Misalignment With Existing Investors Or Lenders
If you already have shareholders, angel investors, or senior lenders, mezzanine debt can create tensions around:
- priority of repayment,
- control and veto rights, and
- what happens if the lender wants to enforce.
Practical tip: don’t treat mezzanine financing as a standalone deal. Consider the whole capital structure and how everyone’s rights interact.
Equity Upside That Creates Future Dilution
Warrants or conversion rights can dilute founders and early shareholders later (sometimes at a time when your valuation is much higher).
Practical tip: quantify the potential dilution up front and ensure it’s consistent with your broader fundraising plans.
Signing Before The Business Is Legally “Ready”
Mezzanine lenders typically do detailed due diligence. If your internal documents are messy (or missing), it can slow down the process or weaken your negotiating position.
Practical tip: get your legal foundations tidy before you enter serious negotiations - corporate governance, shareholder arrangements, key commercial contracts, and IP ownership should be in order.
Key Takeaways
- Mezzanine debt is a form of finance that sits between senior debt and equity, often used to fund SME growth, acquisitions, or expansion while limiting dilution.
- It typically comes with a higher cost of capital than bank lending and may include equity-style features like warrants or conversion rights.
- Key terms to watch include interest structure (cash vs PIK), covenants, fees, and events of default - all of which affect how much flexibility you keep as you scale.
- Mezzanine funding often requires multiple documents, including a finance agreement, security documents, and potentially an intercreditor agreement if a senior lender is involved.
- If mezzanine debt includes equity upside (options/warrants/conversion), you’ll need to ensure your shareholder and governance documents are set up to handle it cleanly.
- Because mezzanine finance is complex and highly negotiated, it’s worth getting tailored legal advice before signing - the details can have long-term impacts on control, dilution, and refinancing options.
Important: This article is general information only and isn’t financial, investment, tax or accounting advice. Mezzanine structures can have different legal, tax and commercial outcomes depending on your circumstances, so it’s a good idea to get advice tailored to your business before proceeding.
If you’d like help reviewing a mezzanine debt offer, negotiating key terms, or getting the right legal documents in place, you can reach us at 08081347754 or team@sprintlaw.co.uk for a free, no-obligations chat.
