What is Subordinated Debt?

Debt

Subordinated debt is a term that is most important when a business becomes incapable of continuing to run its revenue-earning operations, thus necessitating it to either go into bankruptcy or go into liquidation. Like its name suggests, subordinated debt is less than other kinds of debt in the sense that it receives lesser priority than other kinds of debt when it comes to repayment. This makes subordinated debt the opposite to senior debt, which is debt that is “superior” in the sense that it must be paid off before the rest.

Regardless, the result is that subordinated debt is considered to be riskier than other kinds of debt. After all, if the borrower is forced to either go into bankruptcy or go into liquidation, the lender of subordinated debt will get paid after the lenders of other kinds of debt. Effectively, this means that they have a lower expected outcome because their outcome is that much worse should be the borrower become incapable of running their revenue-earning operations.

How Does Subordinated Debt Affect Bankruptcies and Liquidations?

For those who are curious, when a business becomes incapable of running its revenue-earning operations, it will see its assets entrusted to an outsider who will be responsible in using them to pay off as much of its outstanding obligations as possible. Since debt is what the business owes to other parties while equity is the percentage of the owners’ stake in the business’s total value, this means that debtors get paid before the owners, whether those owners are actually called owners or partners or shareholders.

As stated, there are different kinds of debt, with some kinds of debt getting paid off before others. However, it is interesting to note that there can be both secured and unsecured debt as well, meaning whether it has had collateral put up for it or not. Generally speaking, collateral means that the lender will just recoup as much of their losses as possible by claiming whatever it was that was put up for collateral in the first place, meaning that secured debt tends to be seen as being somewhat less risky than its unsecured counterpart.

With that said, it is important to note that these normal rules are somewhat unreliable when it comes to subordinated debt that has been secured through the process of collateralization because it is possible that the borrower won’t actually be able to collect whatever it was that had been put up as collateral. Something that happens so long as the contract makes it very clear that the subordination applies even to the collateral. Due to this, while secured subordinated debt is less risky than unsecured subordinated debt, it is by no means perfect protection, which is something that interested parties will want to take into consideration whenever they make relevant choices.

Regardless, the owners don’t get to recover their investments until the creditors have been paid off. As a result, there is a very real chance that the owners won’t be paid at all because there is no guarantee that the business’s assets will be able to cover all of its outstanding obligations. After all, an asset’s book value is not necessarily an asset’s fair market value when one considers issues such as accumulated depreciation and the limited window of time in which to get a good sale price, meaning that it is not uncommon for a business’s assets to fall short of their book price.

It’s a Riskier Kind of Debt

Summed up, subordinated debt is a riskier kind of debt, which is something that both sides will want to take into consideration when making their choices. For example, businesses tend to be reluctant to issue subordinated debt because they need to offer higher than normal interest rates for the purpose of attracting the attention of interested parties. Meanwhile, lenders need to remember that the nature of subordinated debt increases their chances of being unpaid should something go seriously wrong with the business’s revenue-earning operations. With that said, so long as everyone understands exactly what they are getting into as well as what they can expect, they should be able to make use of subordinate debt while keeping the potential issues down to a minimum.



Add Comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Chris Rondeau
10 Things You Didn’t Know about Chris Rondeau
Steven Wright
The 20 Best Steven Wright Quotes That Apply to Business
Chanel
The 20 Best Coco Chanel Quotes That Apply to Business
Vince Lombardi
The 20 Best Vince Lombardi Quotes That Apply to Business
Vermont
How to File for Unemployment in Vermont
Utah
How to File For Unemployment in Utah
Tennessee
How to File for Unemployment in Tennessee
South Dakota
How to File for Unemployment in South Dakota
San Augustin Church and Museum
The 20 Best Things to Do in Manila, Philippines for First Timers
Wineries in a Carriage
The 20 Best Things to Do in Temecula, CA for First Timers
Lake Catherine State Park
The 20 Best Things To Do in Hot Springs, AR For First-Timers
Newport Pier
The 20 Best Things to Do in Newport Beach, CA for First Timers
2021 Ram Rebel TRX
A Closer Look at The 2021 Ram Rebel TRX
2021 Mazda BT-50
A Closer Look at the 2021 Mazda BT-50
2020 Mazda MX-5 Miata 1
A Closer Look at the 2020 Mazda MX-5 Miata
2020 Polaris Slingshot SL 4
10 Things You Didn’t Know About the 2020 Polaris Slingshot SL
A Closer Look at The Oris Carysfort Reef Limited Edition
MB&F Bulldog
A Closer Look at The The MB&F HM10 Bulldog
A Closer Look at the Favre-Leuba Raider Sea King
A Closer Look at The Casio Pro Trek PRT-B50 Black Titanium
Rob Zombie
How Rob Zombie Achieved a Net Worth of $50 Million
Maddie Ziegler
How Maddie Ziegler Achieved a Net Worth of $5 Million
Cole and Dylan Sprouse
How Cole Sprouse Achieved A Net Worth Of $8 Million
Whitney Cummings
How Whitney Cummings Achieved a Net Worth of $30 Million