Mezzanine or preferred equity. Which fits your company?
Both instruments fill the same gap: the space between what a senior lender will advance and the total your plan needs. They fill it from opposite sides of a line that decides everything downstream. Mezzanine is debt. A loan that sits behind the senior facility, secured and dated, priced in the low to mid teens all-in, with a lender who can enforce if the business misses a payment. Preferred equity is share capital. A class of shares that ranks ahead of the ordinary shareholders and behind every creditor, carrying a fixed return that accrues to exit rather than being paid in cash. Mezzanine is the cheaper instrument and the stricter one; preferred costs more and forgives more. Which fits depends on how much cash the plan throws off, what your senior lender will tolerate, and how you weigh a compounding claim against straight dilution. This guide prices that trade-off for a UK company raising £3m to £15m.
Nearly everything published on this comparison is written for property development, where both names describe layers of a project funding stack. This guide is about trading companies. Written for the borrower’s side of the table. This is general guidance, not advice on your specific facility. It deepens the shorter answers in our working guide.
A loan behind the senior debt, priced for its place in the queue.
Mezzanine sits between the senior debt and the shareholders. It is documented as a loan: a facility agreement, a fixed maturity, and security that ranks behind the senior lender’s, usually a second charge over the same assets. If the company fails, the senior lender is repaid first, the mezzanine lender next, and the shareholders take what remains. That position in the queue sets the price. In the UK lower mid-market, mezzanine runs in the low to mid teens all-in, a step above unitranche and well above bank senior debt. The lenders are debt funds and a small number of specialist houses rather than banks, and the strip is usually sized as a minority of the whole structure, sitting behind a larger senior facility.
The coupon usually splits in two. Part is cash pay, a running interest cost the business services like any other loan. Part is PIK, payment in kind, which rolls up into the loan balance instead of leaving the company. The split preserves cash while the plan builds, and it carries the instrument’s quiet danger: compounding. PIK at 12% rolling up unpaid grows the balance by roughly 57% over four years and nearly doubles it over six, so a slow exit hands a growing share of the equity value to the lender. Some facilities add a warrant, a small option over equity negotiated deal by deal, which means mezzanine can carry a sliver of dilution as well as a coupon.
Because it is debt, mezzanine has to be tolerated by the senior lender above it, documented in an intercreditor agreement, and refinanced or repaid at maturity like any other loan. Whether the layer earns its place at all is a question of its own, answered directly in the hub note on when junior debt makes sense.
A share class ahead of the ordinary, behind every creditor.
Preferred equity is share capital with a queue position written into it. The company, usually a holding company above the trading group, issues a class of shares, preference shares or preferred ordinary shares depending on the drafting, that carry a fixed return and priority over the ordinary shareholders both on distributions and on the proceeds when the business is sold or wound up. It stands behind every creditor: a preferred holder ranks in front of the founders and behind the last unpaid invoice. There is no loan agreement, no security, no charge on the register at Companies House, and no maturity date. The rights live in the articles and the shareholders’ agreement rather than in covenants.
The return is usually a dividend that accrues rather than one paid in cash, and two constraints push it that way. Company law permits a distribution only out of profits available for the purpose, in substance accumulated realised profits less realised losses. Companies Act 2006, section 830. And the senior facility agreement above it almost always blocks or caps cash to shareholders through its permitted payments schedule while the debt is outstanding. So the preferred return rolls up, compounding at its fixed rate, and is settled when the company is sold, the instrument is redeemed, or the structure is refinanced. What the investor holds in the meantime is governance: consent rights over defined decisions, sometimes a board seat, and drag and tag provisions on an exit.
In development finance the same phrase means a layer of a project funding stack between the mezzanine loan and the developer’s equity. The corporate version is the same idea in different clothes: patient capital, priced between debt and ordinary equity, documented as shares. Where it shades into a plain minority equity round, and how to weigh debt against equity in the first place, is the subject of our guide to debt versus equity.
One is a creditor, the other is a shareholder, and everything follows from that.
Start with what happens when things go wrong, because that is what each instrument is priced for. Mezzanine is a creditor. A missed payment or a covenant breach is a default, and after any standstill agreed with the senior lender the mezzanine holder can enforce its security. Preferred equity cannot default. If the business has a bad year the preferred return simply keeps accruing, and the holder’s remedies are the ones in the shareholders’ agreement: consents withheld, a board seat exercised, occasionally a ratchet that shifts value. For a business whose cash flow could wobble, that difference is most of the decision. An accruing instrument absorbs a bad year. A cash-pay coupon arrives whatever the quarter looked like.
Day to day, control feels different too. A mezzanine lender monitors like a lender: financial covenants tested against the plan, monthly or quarterly information, and a conversation that runs through the management accounts. A preferred investor governs like a shareholder: a consent list covering acquisitions, disposals, new debt and management changes, information rights, and often a seat at the board table where the plan is debated rather than reported. Neither is lighter in any absolute sense. A borrower who resents covenant tests may find a consent list more intrusive, because covenants bind outcomes while consents bind decisions, and it is decisions that owners feel.
Tax runs in the same direction with different force. Interest on mezzanine debt is, as a general rule, deductible for corporation tax, and at this ticket size the Corporate Interest Restriction rarely intrudes: it applies only where net interest and financing costs exceed £2m in a 12 month period, with relief above that capped at 30% of taxable profits before interest and capital allowances. GOV.UK, Corporate Interest Restriction. A £5m mezzanine strip at 13% is £650,000 of interest, nowhere near the threshold on its own. Preference dividends point the other way: they are distributions, and no deduction is allowed for a dividend or other distribution in calculating profits for corporation tax. Corporation Tax Act 2009, section 1305. The post-tax gap between the two instruments is therefore wider than the headline rates suggest. The detail belongs with your tax adviser, since results-linked interest and connected-party debt carry rules of their own, but the direction is constant.
The senior lender experiences the two very differently. Mezzanine is another creditor inside its structure, so it demands an intercreditor agreement: ranking, standstill periods, a block on payments to the junior lender while things are bad. Negotiating that triangle takes time and legal fees, and some senior lenders at this end of the market simply decline to have a junior lender behind them. Preferred equity sits outside the debt stack altogether. From the senior lender’s seat it thickens the equity cushion beneath the debt, which supports senior capacity rather than consuming it, and there is no intercreditor to agree. Its cash is still controlled, because the permitted payments schedule will block dividends while the facility runs, but a blocked dividend that accrues is a postponement, not a default. What an intercreditor does, and why the borrower should care about its permitted payments schedule, is set out in the hub answer on intercreditor agreements.
Maturity divides them last. Mezzanine matures, so it adds a date to the calendar that must be refinanced or repaid, usually sitting just behind the senior maturity. Preferred equity has no maturity: the claim compounds quietly until an exit, a redemption or a refinancing settles it. Neither structure is free of a clock. One writes the date down, and the other lets the number grow until you choose the date yourself.
Capital is priced in queue order, and accrual is where the cost hides.
The ordering is structural. Bank senior debt is the cheapest money available to a trading company, lending around 2.5 to 3.5 times EBITDA at a modest margin over SONIA. Unitranche prices above it: in the UK mid-market broadly SONIA plus 550 to 800 basis points, an all-in coupon of roughly 9.25 to 11.75% before fees at mid-2026 rates. Deloitte Private Debt Deal Tracker. Mezzanine sits above unitranche, in the low to mid teens all-in by market convention. Preferred equity prices above mezzanine, because it ranks behind it and holds no security; by the same convention its return is set between mezzanine coupons and the returns ordinary equity investors target. Ordinary equity is the dearest capital of all. None of these layers is a bargain or a rip-off. Each is the market rate for a position in the queue, and the discipline is to pay for no deeper a layer than the gap requires.
These figures are illustrative arithmetic at August 2026 rates, not a quote. Take a business with £2m of EBITDA. Senior lenders offer 3 times, £6m, and the plan, an acquisition with its costs, needs £8m. Three routes close the £2m gap.
Route one: mezzanine
£2m of mezzanine at 13% all-in, split 7% cash pay and 6% PIK. The cash coupon starts at £140,000 a year and edges up as the PIK leg grows the balance. Left to run, the balance reaches roughly £2.53m after four years. The company keeps 100% of its ordinary equity, and adds a creditor, a maturity and an intercreditor to its structure.
Route two: preferred equity
£2m of preferred accruing at the same 13%, used here for comparability although a preferred return would conventionally be set higher than the mezzanine coupon. Nothing is paid in cash. After four years the claim stands at roughly £3.26m, settled ahead of the ordinary shareholders at exit. It adds no creditor, no maturity and no intercreditor, and the senior lender sees £2m more cushion beneath its debt.
Route three: ordinary equity
Sell £2m of ordinary shares instead. On a business worth £10m today that is 20% of the company. If the business sells for £16m in four years, the stake is worth £3.2m, almost exactly the accrued preferred claim in this illustration. The equity route has nothing to service and nothing accruing, and it costs the most if the plan succeeds beyond expectations.
The comparison generalises. An accruing instrument costs less than dilution when the equity value compounds faster than the accrual rate, and more when it compounds slower. A business confident of fast growth rationally prefers the accrual and keeps the upside. A business whose exit might drift should fear compounding more than dilution. Every route starts from the same first number, though: how much the senior layer will carry on its own, which is a question of EBITDA quality and cash conversion before it is a question of structure. Our guide to how much your business can borrow shows how lenders set that number.
Growth plans lean to preferred. Buyout gaps lean to mezzanine.
Preferred equity appears most often around growth. A business investing ahead of its cash flow, opening sites, building a team, carrying the working capital of a bigger order book, often cannot service more cash-pay debt, and the founders do not want to sell a large ordinary stake at today’s value to fund a plan priced at tomorrow’s. A preferred instrument, frequently paired with a small ordinary stake, funds the plan with no running cash cost and leaves the ordinary equity table intact. The money comes from growth investors and minority capital funds rather than lenders, and the negotiation is about the accrual rate, the consent list and the exit rights rather than covenants.
Mezzanine appears most often where a deal has a hard funding number and the senior layer stops short of it: a buyout, an acquisition, occasionally a shareholder restructuring. Its classical home is the sponsor-backed buyout, where an institutional owner adds a mezzanine strip behind the senior debt to complete the structure and treats the coupon as the price of leverage. In owner-managed deals it surfaces in partner buyouts, where the remaining shareholder would rather service a dearer loan than admit a new shareholder at all. The providers sit in the debt fund category rather than the banks, and how a full buyout stack fits together, senior, junior, vendor paper and equity, is the subject of our guide to financing a management buyout.
Without an institutional sponsor, both instruments get scarcer and more structured. Providers price governance as well as credit, so a sponsor-less borrower should expect fewer offers, more consent rights and more interest in a board seat, whichever side of the line the instrument sits. That is a reason to run a wide process, not a reason to accept the first structure offered.
Most funding gaps at this size close more cheaply than this.
Junior capital is priced for the bottom of the queue, so the first discipline is to test whether the queue is as long as it could be. A gap above bank senior debt is often better closed by stretching the senior layer than by layering beneath it. A unitranche facility will typically lend a turn or more beyond a bank, in one document with no intercreditor, and at this end of the market one stretched facility is usually cheaper and simpler than a senior plus mezzanine stack, a comparison we price in unitranche versus bank senior. An asset-rich balance sheet can do better again through asset-based lending, which prices against receivables, stock and plant rather than a cash flow multiple. And in a buyout, vendor paper is cheaper than either instrument: a seller persuaded to leave more in, paid over time, is frequently the best value junior capital in the deal.
Sometimes the honest answer is the one nobody is selling. If the plan needs capital that trading cannot service and the growth case will not outrun an accrual, the sound structure is ordinary equity that shares the risk, or a smaller plan. A junior layer in that situation does not solve the problem; it schedules it. For an ordinary trading business, reaching for mezzanine or structured preferred is usually a sign the plan carries more funding than the business can hold, and an adviser paid by you should say so. Buying the gap with the priciest capital available should be the conclusion of a process that tested the cheaper layers first, never the opening move.
We will price the gap before you choose how to fill it.
If a plan or a deal has outgrown what the senior market will carry, the sequence matters more than the instrument. We test the senior layer first, across banks, specialists and funds, then price the junior routes side by side, mezzanine, preferred and vendor structures, with the all-in cost of each to your likely exit, including the honest case where the right answer is a smaller raise or straight equity. See how a mandate runs in how we work, or the full range of what we advise on in our services.