Mezzanine capital exists to close the gap between what a senior lender will underwrite and what a sponsor wants to put in as equity — priced for the subordinated risk it takes on, and structured to be paid in kind as often as in cash.
Key takeaways
Deavo’s own capital-stack breakdown places mezzanine specifically at the mid-market band, roughly $5,000,000 to $30,000,000 of deal size, describing typical mid-market leverage as around 3.0× EBITDA in senior debt priced near 10%, plus about 1.0× EBITDA in mezzanine at 8–12% (often with PIK interest), for total leverage around 4× EBITDA — 5–6× on more aggressive structures. Sponsor equity at that band runs 35–45%, well above the roughly 25% typical on a sub-$1,000,000 deal, and deal pricing itself sits around 6–8× EBITDA as enterprise value.
The reason mezzanine shows up specifically once a deal clears roughly $5,000,000 is arithmetic, not convention. A senior lender's own debt-service coverage test caps how much senior debt the target's cash flow can support, typically at a ratio of roughly 1.2–1.5× EBITDA at this deal size (see the DSCR glossary entry). Below that size, a sponsor can usually close the remaining gap with vendor financing or additional equity. Above it, the gap between senior debt and the sponsor's target equity check becomes large enough that a distinct, more expensive layer of subordinated capital becomes the more efficient way to fill it than simply writing a bigger equity cheque.
Payment-in-kind interest means the mezzanine lender's interest accrues to the outstanding loan balance rather than being paid in cash each period. Deavo’s breakdown notes mid-market mezzanine is “often” structured this way. The mechanical reason is straightforward: the senior lender's own debt-service coverage test is calculated against the cash the business actually has to pay out each year, and every dollar of mezzanine interest paid in cash competes directly with the senior lender's own debt service for the same cash-flow cushion. PIK interest removes that competition — the mezzanine lender still earns its return, but the return compounds onto a larger principal balance due at maturity or refinancing rather than draining current cash flow. See the unitranche glossary entry for a related structure that blends senior and mezzanine risk into a single facility instead of layering them.
The trade-off is size, not just cash flow: PIK accrual means the amount actually owed at exit or refinancing is larger than the amount originally drawn, compounding at the stated rate over the holding period. A sponsor modelling an exit needs to carry the accreted mezzanine balance forward, not the origination amount, when sizing what equity actually clears after debt is repaid.
The general interest-deductibility test in the Income Tax Act does not distinguish between senior and subordinated debt, or between cash and accrued interest, on its face. Paragraph 20(1)(c) allows a deduction for “an amount paid in the year or payable in respect of the year… pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property.” The provision's own wording covers an amount “payable in respect of the year,” which is the language that matters for PIK structures — interest that accrues rather than being paid in cash can still fall within the deduction where it is legally payable in respect of the year and the borrowed money was used for an eligible purpose, though the precise mechanics of when accrued PIK interest becomes deductible in a given structure are a question for the buyer's own tax advisor, not a general rule this article can settle on its own.
A mezzanine lender almost never competes with the senior lender for first-ranking security over the same collateral pool. It takes a subordinated interest instead, priced into the rate rather than fought for in the security registration — see how a subordination agreement actually ranks two lenders for the mechanics of how that gets documented. Because the mezzanine lender's return already reflects the risk of standing behind the senior lender on enforcement, financial covenants attached to a mezzanine facility often run tighter than the senior lender's own covenant package, as the mezzanine lender's main protection against deterioration is early warning, not collateral priority. See the financial-covenant glossary entry and the senior-secured-term-loan glossary entry for how the two facilities typically compare.
A sponsor is acquiring a specialty manufacturer for $14,000,000, against trailing EBITDA of $2,400,000 — a purchase multiple of roughly 5.8× EBITDA, inside the 6–8× range this band typically sees. Applying the mid-market band: senior debt at 3.0× EBITDA is $7,200,000; mezzanine at 1.0× EBITDA is $2,400,000; sponsor equity and a small seller rollover fill the remaining $4,400,000, roughly 31% of price — on the lower end of the 35–45% band because the purchase multiple itself sits below the top of its range.
The mezzanine tranche is priced at 4% cash-pay plus 6% PIK. In year one, the sponsor pays $96,000 in cash interest on the $2,400,000 mezzanine balance, while $144,000 of PIK interest accrues, bringing the balance to $2,544,000 entering year two. By year three, assuming the same 6% PIK rate compounding annually on the growing balance and no principal repayment, the accreted mezzanine balance has grown to roughly $2,860,000 — about $460,000 more than the amount originally drawn. If the sponsor plans to refinance or sell within three years, that accreted balance, not the $2,400,000 origination amount, is what has to be repaid out of proceeds before the equity return is calculated. The senior lender's own debt-service test, by contrast, is calculated only against the $7,200,000 tranche and its cash-pay interest, since the mezzanine's PIK portion never touches the cash-flow cushion the senior lender is protecting.
Not typically. The sourced market data here places mezzanine specifically at the mid-market band, roughly $5,000,000 and up; smaller deals more commonly close the equity gap with vendor take-back financing instead.
No presumption either way is safe here. Paragraph 20(1)(c) covers interest “payable in respect of the year,” which is broader than interest actually paid in cash, but exactly when accrued PIK interest becomes deductible in a specific structure is a question for the buyer's own tax advisor.
It does not accept a similar return — the 8–12% pricing is specifically compensation for standing behind the senior lender on enforcement. The subordinated rank and the higher rate are the same trade, not two separate features of the facility.
A 30-minute call is enough to tell you whether AI pays for itself here.
Nobody publishes Canadian transaction data, so every valuation in this country quotes an American benchmark. We are building the Canadian one — multiples, asking-to-sale spreads and days on market, by sector and by city. Leave an email and you will see it first.
No pitch, no listings. One email when the first report lands.
