What Is Sub-Debt Lending?

When your business files for bankruptcy, your debts fall into some sort of hierarchy. The tax people must be paid first, and then there is also the senior debt level. Only when your debts to these organizations have been fully paid can the subordinated debt (the lowest level) be paid. From this perspective, it’s easy to see why lending money to businesses is a very risky proposition for a lender. This is why many lenders offer subordinated lending, or just sub-debt lending.

Who Offers Sub-Debt Lending?

The most typical source of sub-debt loans are subordinated debt funds. Since the loan is much riskier for the lender, the interest can be considerably higher than with traditional bank loans. These lenders look for specific signs in your business before they will agree to provide sub-debt lending.

  • The loan is mostly short term and is given if you need it for growth.
  • Your business should have some type of asset which can be financed, such as valuable patents, popular intellectual property, or accounts receivables.
  • Your cash flow should be stable, or at the very least there’s a very strong possibility of more than sufficient cash flow.
  • You have a very profitable company.
  • Your records and financial controls are solid.
  • Your company is free from any performance obligations.
  • Modeling and forecasting are already in place.
  • You’re willing to accept reporting disciplines and financial covenants imposed by the lender, and you’re also willing to be a guarantor of the loan.

Basically, your company should have proven management and financial strength, along with a significant growth potential. The sub-debt lenders are willing to take the risk, but there should be a sizable return for everyone as well.

Benefits and Drawbacks of Sub-Debt Lending

In some ways, sub-debt loans may be more preferable than the alternatives. For example, while this form of funding may be more expensive than traditional loans, in the long run it’s still cheaper than if you sell a slice of your company to an investor. If your company grows to unprecedented heights, then the value of that slice you sold would be much more than what you got as a loan.

Usually, the interest payments on subordinated debts are also tax-deductible, and that reduces your taxable income. Your equity position may also improve, as a bank may consider it as part of your equity in service of the senior bank debt.

The main drawbacks to sub-debt loans is that you will have meet the interest and principal payments as part of the contract, no matter what your current finances may be like. You may also have to deal with some imposed restrictions on what the company and the management can do. And you may also have to put up some collateral for the loan, and this may include your personal guarantee.

But if you have the “signs” that sub-debt lenders are looking for, then perhaps sub-debt lending can be the answer to your capital problems.

Published by

Chris Lanchech

Hi everyone, my name is Chris and I am a junior analyst at Neebo Capital and an inspiring blogger. We enjoy speaking with business owners and entrepreneurs who come to Neebo Capital looking for cash flow solutions. Give us a call toll free at 1-888-382-3766 or Visit us online at www.neebocapital.com

Leave a Reply

Your email address will not be published. Required fields are marked *