What is Subordinated Debt Financing?
Subordinated Debt financing (or sub debt) exists in between senior debt and equity, and therefore is “subordinated” to, or is second in “priority” to any senior debt (meaning the senior gets paid off first in the event of a liquidation) but sub debt does have priority in repayment versus equity.
Furthermore, sub debt is a highly customizable financing solution based on the strength of your business and can be structured to fit different types of security, repayment terms, and debt servicing capacities. Another significant benefit of sub debt is that it is dilution-free, so the company’s’ owner(s) keep all of the common stock, and endure none of the headaches of minority equity ownership.
A subset of sub debt, known as mezzanine debt, has both debt-like features and equity-like features, as it resides in between and has characteristics of both senior debt and equity. The debt-like features include an interest rate that must be paid in cash, or it can be deferred through a payment-in-kind (PIK) structure. The equity-like features allow the provider of the mezzanine debt to participate in the upside of the business, like equity owners, typically through equity warrants, either struck at a penny, or at the market (or anywhere in between, subject to negotiation) or the lenders can request common stock as a “kicker”, although warrants are more tax efficient.
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