How to model mezzanine debt in paper lbo

Hi,

How would we model mezzanine debt in a paper LBO? Would it dilute equity at exit because it would be converted to equity? If so, does it make sense that it both has an interest rate and is converted to equity at exit?

Thank you for your help!!

 

Depends on if it's convertible or not. 

If it's not convertible or it does not convert, then you basically model its IRR as with any piece of debt. Just flow the CF each year + repayment and apply an XIRR function to pull IRR.

If it is convertible and it does reach strike, then you still model the CF up until the conversion point, then convert, and at end of holding period, model as you'd sell the equity holding (assuming dilution as well). At the end of the day, this is still just a series of cash flows by time period, so use XIRR again.

 

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