Subordinated Loans: What Are The Benefits

Subordinated loans are loans made by a secondary lender who takes a lower priority than senior lenders. In the case of bankruptcy, the subordinated lender will have to wait until senior lenders are paid off before receiving any returns. Other than these primary differences, there are a number of small nuances with subordinated loans that allow for both borrowers and investors to profit substantially.

Arrange Additional Financing

The main reason companies seek additional lenders through subordinated loans is because they cannot always receive enough capital through a primary lender. Primary lenders have very strict guidelines to financing limits and interest rates. They are typically publicly held companies, such as banks, insurance companies and other institutions. Subordinate lenders tend to be private investors or private investment groups such as mutual funds or private equity teams. They can agree to financing if they determine the business plan of the borrower is sound and want to be part of the venture. They are not operating under the same restrictions as senior lenders because they are not regulated in the same manor and not responsible to as many investors, if any. When a company needs more cash and cannot secure it through a traditional bank, subordinate lenders are an attractive option.

Strengthen Financial Position

Most subordinate loans are unsecured loans, meaning no collateral is posted. When no collateral is posted, the new loan appears as increased equity in the company. This means the company's financial position is strengthened in the eyes of outside investors and lenders. While a subordinated loan is technically still a form of debt, it is really seen as an influx of capital across the board. Getting the debt unsecured will make the loan more costly to the borrower. To compensate for this, the borrower typically offers some type of equity or yields to the lender as opposed to a straight interest rate. If the yields continue to meet the subordinate lender's goals, they will often continue to provide capital funding to the venture. 

Derive Flexible & Mutually Beneficial Agreements

A major benefit of working with a subordinate lender is the flexibility of the loan agreement. The lenders are more concerned with the overall yield of the company, because this will ultimately raise them the highest amount of profit on the loan, and will work to put in place the most beneficial structure to raise profits. They will typically have the borrower's best interest in mind. This provides for long-term cash flow agreements between the two parties. If the borrower's business plan fails, these deals can quickly turn sour. However, as long as the yields are high, subordinate lenders can usually establish long term relationships with the borrower. Because of their interest in the success of the company, subordinate lenders may also serve in an advisory role. Many business owners fear passing on any control to the lenders. If the lender has experience in the industry or with other successful ventures, though, the advice and counsel can strengthen the company's business plan.