Senior and mezzanine finance

What senior and mezzanine debt are

Senior debt is the first-ranking, secured loan in a company’s funding. It is repaid first if things go wrong, so it costs the least.

Mezzanine ranks behind senior debt but ahead of shareholders. The British Business Bank describes it as a type of unsecured business loan that is a mix of two different types of financing, and notes that it is often shown as equity on a company's balance sheet.

Two features set mezzanine apart. PIK (payment-in-kind) interest is interest paid at the loan maturity or when refinanced: it is added to the loan rather than paid in cash. An equity kicker gives the lender a Variable share of the business upside taken through either an equity warrant or a levy on the profits (British Business Bank research, 2022).

How to work out the blended cost of senior and mezzanine debt

1. Enter EBITDA and EBIT. Use the figures the lenders will test covenants against.
2. Enter the senior loan. Add the amount, SONIA, the margin and the arrangement fee.
3. Enter the mezzanine terms. Split the coupon into cash and PIK, and add the fee and any warrant value.
4. Check cover and leverage. See how PIK grows the debt over the term, and whether earnings still cover the cash interest.

When businesses use it

Senior and mezzanine debt together fund buyouts, management buyouts, acquisitions and growth projects where senior debt alone does not cover the need and the owners want to limit dilution. In the British Business Bank’s example, a £1,000,000 project is funded with £600,000 from the bank, £200,000 from shareholders and £200,000 of mezzanine.

Mezzanine is rare among smaller firms. British Business Bank research from 2022 found less than 0.5% of all smaller businesses having used mezzanine finance in the last 3 years.

For larger sponsor-backed deals it is being replaced by a single blended loan. Deloitte (Deloitte, Autumn 2025) found that Unitranche structures remain the workhorse across Europe, with mezzanine increasingly sidelined. See unitranche and direct lending. Where senior debt or a government-backed loan covers the need, mezzanine is usually not used.

How much of the funding each layer provides

The British Business Bank says that, for mezzanine, A typical range for this type of financing is between 10% and 30% of the funding. Its 2022 growth loans report shows a representative buyout funded 50% by senior debt, 10% by mezzanine and 40% by equity (chart, 2022).

Deloitte’s Autumn 2025 chart of alternative structures shows bank senior debt of Up-to 2x Senior Debt S+[50-350]bps, stretched senior at 4.5x Senior Debt S+[550-600]bps and second lien at 4x Second lien S+[700-900]bps. The multiples are total debt to EBITDA for each structure, not layers to add together. Margins have since tightened, so treat these as dated indications, not current pricing.

Terms and repayment

Bank senior debt has a Shorter tenor (3-5 years) and is Partly amortising (Deloitte, Autumn 2025). Mezzanine usually runs longer and is repaid at the end: Some mezzanine finance deals involve a bullet payment at the end (British Business Bank research, 2022).

Repayment terms can include both fixed and variable interest, and in some deals the lender can exchange the remaining loan for a share in the company. PIK interest compounds, so the mezzanine balance grows each year it is outstanding.

What it costs

Senior debt is priced as a margin over SONIA (3.7335% as at 15 October 2026 (Bank of England database (IUDSOIA))) or Bank Rate (3.75% as at 19 October 2026 (Bank of England)). As a benchmark, the Bank of England reports The effective interest rate on new loans to SMEs increased to 6.63% from 6.61% in August 2026.

Mezzanine costs much more. In 2022 British Business Bank research, Respondents report mezzanine loans are generally priced at 10-15% interest rates, plus minority equity warrants/ performance payment, giving an expected return in the region of 13% to 20% IRR over a 5 year period (1.5 to 1.7 times money back). Deloitte’s Autumn 2025 tracker shows mezzanine funds targeting gross returns of 12–18%. The Development Bank of Wales notes that because alternative lenders take more risk, their loans will usually be subject to higher interest rates.

Example With the calculator defaults (£12m senior at SONIA plus 4.5%, £4m mezzanine at 8% cash plus 4% PIK, over 5 years), cash interest is about £1.31m a year and the PIK adds about £867,000 to the mezzanine, which grows to £4,866,612. Debt rises from 4.0 to about 4.2 times EBITDA, and EBITDA covers the cash interest about 3.06 times.

Security, ranking and covenants

Senior lenders take first-ranking security. Mezzanine is subordinated, and Subordinated security usually requires an inter-creditor agreement (British Business Bank research, 2022). This agreement sets out which lender is paid first, and when the mezzanine lender can and cannot take action.

Expect financial covenants. HMRC notes that Loan covenants commonly include a maximum ratio of debt to earnings and a minimum ratio of earnings to interest costs. A law firm’s briefing lists a Leverage covenant: a test of debt to EBITDA, a cashflow cover covenant and an interest cover covenant. HMRC’s worked example: if the interest payable is £3m, then EBIT is £12m and the interest cover is 4:1. That is an example, not a market standard.

If a covenant is likely to be breached, the company will need a waiver or a covenant re-set unless it refinances or is sold. Lenders usually attach conditions and fees to a waiver.

Who qualifies

Lenders look for an established, profitable business with predictable cash flow, and test it on EBITDA. The British Business Bank’s checklist for business borrowing is a useful starting list: Management accounts, Business plan, Historic accounts and Details of assets.

For senior debt, the Growth Guarantee Scheme can support lending to businesses with turnover of up to £45m. The British Business Bank says that If a lender can offer a commercial facility on better terms than a GGS-backed facility, they will do so. Mezzanine takes longer to arrange; the British Business Bank says it can often take quite a long time.

Who provides it

• Senior debt: high-street, challenger and specialist banks, including lenders using the Growth Guarantee Scheme.
• Mezzanine and junior debt: mezzanine and private credit funds. The 2022 British Business Bank report says Growth loans include … unitranche, mezzanine, subordinated debt, junior debt and second lien.
• Development banks: the Development Bank of Wales explains how buyouts can be financed (guide).

Some funds provide both layers as one unitranche loan.

Pros and cons