A software company is being bought at 8x ARR with a senior loan, a mezzanine tranche and equity. Compare risk and return in each layer of the capital structure and say where you would invest and why.

The senior sits at 25% of value for 10%, the mezzanine from 25% to 42% for about 13.4%, and the equity from 42% up for 29% in the plan but 0.09x in the bear case. Value must fall 52% before the mezzanine loses a rupee and 75% before the senior does, and both are whole even in the bear case. I would take the mezzanine: 13% with the cushion of Rs 700 crore of equity beneath it, paid in full in all three cases, while the equity's 29% depends on the multiple holding.

Think of three people lending to a shop: the bank with a charge on the building, a relative who lends against the owner's promise and charges more, and the owner's own savings, which are the first money lost if trade fails. The senior loan is the first Rs 300 crore of Rs 1,200 crore of value, 25% loan to valueThe claim divided by the value of the business. For a tranche it is read as a band: the point in the stack where it starts and where it ends.; the mezzanine is the next Rs 200 crore, taking the band to 42%; and the Rs 700 crore of equity is everything above. Value falls from the top: the equity absorbs the first 52% of any decline, and the senior is touched only after a 75% fall, which at 8x ARR means the company selling for 2x ARR.

Cash interest is 10% of Rs 300 crore plus 6% of Rs 200 crore, Rs 42 crore a year, against EBITDA of Rs 30 crore in year 1. Cover is 0.71x, 0.95x, 1.24x and 1.57x across the four years, so the first two years draw on the Rs 40 crore of opening cash and the plan only becomes self-funding in year 3. The mezzanine's 8% PIK is not generosity; it is the recognition that the company cannot pay 14% in cash, and it means the mezzanine claim grows to Rs 272 crore by year 4. A lender who values this deal on ARR cover alone has not looked at the cash.

The mezzanine, and say why in terms of the two numbers that matter. It earns about 13% a year with Rs 700 crore of someone else's money beneath it, and it is repaid in full unless the company is worth less than about 3.8x its current ARR in year 4, which even the bear case clears. The senior is safer still but 10% is thin pay for a loan whose cash interest is not covered until year 3. The equity's 29% in the plan is attractive, but it is a bet that 8x ARR holds for four years; at 6x and 12% growth it makes 1.21x and at 3.5x it loses nearly all of it. The limit of the answer is the entry price: at 8x ARR the whole stack rests on the market continuing to pay for recurring revenue, and a mezzanine investor should ask for a lower entry multiple, tighter PIK terms or a slice of the equity before being comfortable.