Typical Subordinated Debt

Subordinated debt is generally a financial liability that is unsecured and entails minimum consequences if unpaid. If a debt is liquidated, all senior and secured debt will be paid off first. If assets remain, then those that provided subordinated loans are paid. A common example of a senior, secured debt is a mortgage. Nonpayment means the loss of the home. A subordinated debt can be thought of as an informal loan between friends.

Subordinated or Junior Debt

Subordinated debt (also called "junior debt") can be found throughout the corporate and private world. Senior debt is relative to each entity's situation. A secured loan that has a payoff time frame of one month, is senior to a junior debt of an unsecured loan that can be paid off in years.

Banks and Financial Institutions

Businesses generally have a more difficult time attaining junior debt from a bank or financial institution. The lender is at great risk since in the case of default, the bank must wait in line behind all the senior debt to regain their loss. To make up this risk, financial institutions will generally only offer subordinated loans at a very high interest rate.

Warrants As Coverage

More typical than an outright loan, lenders to a business will allow subordinated debt and request issuance of warrants or convertible bonds as leverage against a default. If the business does become viable, the lender has the ability to redeem these warrants as shares. Subordinated debt lenders are paid after senior debt lenders, but they do have priority over common stock holders when it comes to reimbursement.

Subordinated Debt Firms

There are many firms throughout the US that specialize in helping businesses with subordinated debt. Such firms can be found through hiring a corporate finance advisor, or developing a relationship with a venture capitalist. CapitalSouth Partners, a junior debt lender in the Southeast, generally lends businesses from $2 million to $10 million to be used for growth and restructuring. The typical borrower has an annual revenue over $10 million and between $1 million and $10 million in EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). CapitalSouth charges 12 percent to 14 percent for the loan (2002), and receives "warrant coverage" equal to 10 percent to 20 percent of the business' outstanding stock.

When Issued

Many times, lenders only issue junior debt after a person or business has used the maximum available senior debt a lender is willing to offer. Often, for a business, subordinated debt is issued from a parent company or through leveraged buyouts of other companies.