Temporary Equity (Mezzanine Equity)
Instruments shown between liabilities and permanent equity on the balance sheet, such as redeemable preferred stock whose redemption is not solely in the company's control.
Temporary Equity (Mezzanine Equity)
Temporary equity, also called mezzanine equity, is a class of instruments presented on the balance sheet in a separate section between liabilities and permanent shareholders' equity. It exists because certain securities are not quite debt and not quite common equity: they carry an obligation or possibility of redemption that is outside the company's sole control, so accounting rules refuse to classify them as permanent equity while also not treating them as a liability.
What qualifies
Under US accounting rules (notably SEC guidance ASR 268), an instrument is classified as temporary equity when it is redeemable:
- at a fixed or determinable date,
- at the option of the holder, or
- upon an event not solely within the issuer's control.
Why the distinction matters
The classification changes several things an analyst cares about:
- Leverage and solvency. Temporary equity is not debt, so it does not appear in reported liabilities, but it is a potential future cash outflow. Ignoring it understates the claims ahead of common shareholders.
- Book value of common equity. Because temporary equity sits above common equity, it reduces what is left for common holders. Return-on-equity and book-value-per-share calculations should be based on permanent common equity, not total equity.
- Enterprise value. Redeemable preferred and redeemable minority interests are claims senior to common stock and are often added to enterprise value alongside debt.
Worked example
A company reports total equity of $600m. Of that, $150m is redeemable preferred stock classified as temporary equity, sitting above the common line.
- Permanent common equity = $600m - $150m = $450m
- Net income to common = $60m
- Return on common equity = $60m / $450m = 13.3%
The practical read
Temporary equity is a warning label: it marks capital that may have to be paid back and claims that sit ahead of common stock. When a company carries a large mezzanine balance, common shareholders own a thinner slice of the business than the headline equity suggests, and a redemption event can pull real cash out of the company. Always separate permanent from temporary equity before computing per-share and return metrics.
Frequently asked questions
What is temporary equity?
It is a balance-sheet category between liabilities and permanent equity for instruments that are redeemable outside the issuer's sole control, such as redeemable preferred stock or redeemable noncontrolling interests. It is neither a normal liability nor permanent equity.
Why is temporary equity separated from permanent equity?
Because the holder or an outside event, not the company, can force redemption for cash. That contingent obligation prevents it from being permanent equity, but since redemption is not certain, it is not classified as a liability either, so it sits in the mezzanine between them.
How does temporary equity affect return on equity?
It sits above common equity, so it should be excluded when computing returns to common shareholders. Using total equity including the mezzanine understates ROE and book value per share, because part of that equity belongs to senior redeemable claims, not common holders.