Mezzanine Debt

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DEFINITION of 'Mezzanine Debt'

When a hybrid debt issue is subordinated to another debt issue from the same issuer. Mezzanine debt has embedded equity instruments (usually warrants) attached, which increase the value of the subordinated debt and allow for greater flexibility when dealing with bondholders. Mezzanine debt is frequently associated with acquisitions and buyouts, where it may be used to prioritize new owners ahead of existing owners in case of bankruptcy.

BREAKING DOWN 'Mezzanine Debt'

Some examples of embedded options include stock call options, rights and warrants. In practice, mezzanine debt behaves more like stock than debt because the embedded options make the conversion of the debt into stock very attractive.

Under U.S. Generally Accepted Accounting Principles (GAAP), how a hybrid security is classified on the balance sheet depends on how the embedded option is influenced by the debt portion. If the exercising of the embedded option is influenced by the structure of the debt portion in any way, then the two parts of the hybrid (debt and the embedded equity option) must be classified in both the liability and stockholders' equity sections of the balance sheet.

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