Module IV· InterestIntermediate
Question
What is cash conversion on a mezzanine investment for the lender?
Answer
Mechanics
Cash conversion ratio on mezz = cash coupon / total yield. It measures how much of the return comes as ongoing cash versus compounding / an equity kicker.
Deep diveShow more details
Example
Mezzanine $100m, 8% cash + 5% PIK + 1% equity kicker = 14% total yield.
| Component | Annual yield | Cash component |
|---|---|---|
| Cash coupon | 8% | 8% (full cash) |
| PIK | 5% | 0% (compounding) |
| Equity kicker | 1% (estimated) | 0% (exit-only) |
| Total | 14% | 8% cash |
| Cash conversion | -- | 8/14 = 57% |
Impact on the lender
- Low cash conversion (50-60%) = higher liquidity risk, more yield concentrated at exit
- High cash conversion (80%+) = the lender needs cash flow for investor distributions
- Mezzanine funds typically prefer 50-70% cash conversion — a balance between yield and liquidity
Pitch tip
Question: "Why does the lender take PIK instead of 100% cash?"
Answer: "PIK is more cash-flow-friendly for the sponsor, which gives the mezz lender less distress exposure. As a compromise: mezz accepts 50-60% cash conversion in exchange for a premium on total yield"