How to Start a Mezzanine Fund

In a lower-middle-market buyout, senior lenders might stretch to 3.0–3.5x EBITDA while the deal needs 4.0–4.5x of total funding before equity. The tranche in between is mezzanine: subordinated, often unsecured or second-lien, repaid after the senior lender and before the equity. You're paid for the seat — double-digit coupons — and for the patience, since mezzanine typically has no amortization and gets taken out at exit or refinancing.

The strategy's pitch to LPs is the return shape: contractual current income floors the return like credit, while warrants and equity co-invests add a capped-but-real upside kicker that pure senior lending never has. The corresponding risk is first-loss-among-lenders — when enterprise value sags, mezzanine absorbs the damage before the senior tranche feels it — which is why underwriting quality and intercreditor terms carry the diligence weight.

A mezzanine security is assembled from three components, and your PPM should state the target blend:

Every mezzanine position lives under an intercreditor agreement with the senior lender, and the terms decide what you're worth in a downside case: subordination scope (payment versus lien), whether your cash interest can be blocked while a senior default runs and for how long (standstill periods), your cure rights when the borrower trips senior covenants, and whether you can buy out the senior position at par to take control of a workout.

This is a named LP diligence topic for mezzanine specifically. A manager who can walk through their standard intercreditor asks — and which points they've conceded in real negotiations — demonstrates the craft; one who treats it as boilerplate hasn't been through a workout where the boilerplate decided the recovery. If your team lacks that scar tissue, pair with counsel who has it and say so in the deck.

Mezzanine deal flow comes from two channels, and LPs will map yours. Sponsors bring you into buyouts that need gap financing — which means PE relationships where you're a known, fast, reasonable counterparty across repeated deals. Senior lenders and debt advisors refer deals their hold limits or leverage caps can't finish — which means banks and credit funds who trust you to behave in the intercreditor negotiation and in a workout.

The pitch-deck version of this is a named, dated pipeline: sponsors you've closed with or quoted for, the senior lenders you've sat across, and the repeat-deal pattern that shows the phone rings. Non-sponsored mezzanine — subordinated loans direct to founder-owned companies — exists and prices wider, but it's a different diligence and workout burden, and a first fund should state which business it's in.

Mezzanine holds run three to six years with no liquidity until exit or refinancing, so the fund is closed-end: committed capital drawn as deals close, a 3–4 year investment period, a 7–10 year term with extensions. Current income distributes quarterly as cash coupons are collected; PIK accrual and warrant gains arrive as realizations, which is why mezzanine waterfalls typically return capital plus the preferred before incentive participates (European-style).

Economics sit between credit and buyout, reflecting the return profile: a 1.5–2% management fee (on committed during the investment period, invested after — with LP pressure toward the invested basis), a preferred return of 7–8%, and carried interest of 15–20% — the top of that range earned by warrant-driven realized track records, not asked for on fund one.

The Fund Builder models the fund — target raise, cash/PIK/warrant target structure, investment period, hurdle, carry, fee basis — so the return math in the pitch deck Scroll Deck builds decomposes into the same coupon, PIK, and warrant assumptions your documents describe. Legal Canvas prepares the formation and offering documents for independent counsel review — with deal-level intercreditor negotiation remaining exactly where it belongs, in counsel's hands per transaction. The fund formation package is $6,000, prepared in days rather than months, and the generated fund site gives sponsors and LPs the same institutional-grade front door.