Preferred equity or mezzanine debt? How to choose the middle of the stack

When the senior loan and the sponsor's equity do not add up to the total cost, something has to fill the middle. The two most common answers are mezzanine debt and preferred equity. They look similar on a capital stack chart. They behave differently when things go wrong.

Mezzanine debt

Mezzanine debt is a loan that sits behind the senior mortgage. It is usually secured by a pledge of the ownership interests in the borrowing entity rather than by the property itself.

• Payment: a fixed interest rate, current or partly accrued.
• Remedy: if the borrower defaults, the mezzanine lender can typically foreclose on the ownership interests, often faster than a mortgage foreclosure.
• Senior lender view: governed by an intercreditor agreement that sets each lender's rights.

Preferred equity

Preferred equity is an ownership position in the deal with priority over the common equity. Instead of a lien, the investor holds rights written into the operating agreement.

• Payment: a preferred return, paid before common equity receives distributions, sometimes with a share of upside.
• Remedy: if targets are missed, rights can include taking control of management or forcing a sale, depending on the agreement.
• Senior lender view: some senior lenders accept preferred equity where they would not allow mezzanine debt, because it is not a second loan.

How sponsors choose

Consideration	Mezzanine debt	Preferred equity
Position	Lender	Owner
Security	Pledge of ownership interests	Rights in operating agreement
Senior lender approval	Intercreditor agreement	Often simpler, varies by lender
Typical cost	Fixed rate	Preferred return, may include upside
Control risk	Foreclosure on interests	Management takeover or forced sale rights

The right choice depends on what the senior lender allows, how much control you are willing to put at risk, and how the cost compares to the returns the business plan supports.

Before you sign

Read the default and control provisions as carefully as the pricing. The cheapest capital can be the most expensive if it lets someone take the keys after one missed quarter.

Our Capital Stack Builder shows how each layer changes your blended cost and equity requirement. When you are ready to structure the real thing, talk with us.

Thomas Capital Holdings does not sell securities or solicit investors. Any equity investment is made by the issuer under its own documents and applicable law.