Introduction: Senior Debt and Junior Debt
Senior Debt and Junior Debt (Subordinated Debt or Mezzanine Debt) both are long-term liabilities or non-current liabilities of the company. They are an important source of finance in debt financing. There are times when the Cost of Equity exceeds the Cost of Debt; in such a situation, preference shifts from equity to debt. Senior Debt and Junior Debt is an important tools for debt financing. They help the company in both in the short as well as long term. Though their ultimate objective to gather resources is almost the same, they have different characteristics altogether. They both act as a source of finance for the issuing company, but they both carry different levels of risk, interest rate, and repayment priority. They may attract different kinds of investors/lenders, etc.
Senior Debt and Subordinated Debt are recorded in the Balance Sheet under the head of non-current liabilities. They are recorded according to their repayment priority at the time of bankruptcy. And so, Senior Debt is recorded first, followed by the Subordinated Debt. The cash raised through both these types of debts is recorded in the cash account of the company. If any asset is purchased out of this cash, the same asset is recorded on the Asset side of the Balance Sheet. The cash outflow thereby gets record in the cash account.
Differences: Senior Debt and Subordinated Debt
Major Differences between Senior Debt and Subordinated Debt are as follows:-
|Senior Debt is a type of non-current debt that has the very first repayment priority at the time of liquidation or bankruptcy.
|Junior Debt is also a type of non-current debt, which gets second repayment priority in comparison to Senior Debt at the time of liquidation or bankruptcy.
|As the name suggests, it is having a senior or topmost priority at the time of liquidation or bankruptcy.
|As the name suggests, this debt is having junior priority at the time of liquidation or bankruptcy.
|In comparison to Junior Debt, it gives lower interest rates to the investors.
|In comparison to Senior Debt, it provides higher interest rates to the investors.
|It is mostly backed by collateral security.
|It is mostly not backed by any collateral security.
|This is lesser riskier because of the collateral backing.
|This is riskier in comparison to Senior Debt.
|It is a comparatively cheaper source of debt finance for the issuing company.
|It is a comparatively costlier source of debt finance for the company with respect to senior debt.
|Senior Debt is a vital and primary source of debt for the company.
|Junior Debt is the least important debt for the company.
|The issuing company prefers getting Senior Debt above the Junior Debt. The company first tries to get Senior Debt up to the maximum level at lower interest rates.
|The issuing company prefers shifting to the Junior Debt only after it cannot further avail of any Senior Debt.
|Senior debt holders are not concerned with the company’s growth and profitability. They only need their interest timely and return of principal at maturity.
|Junior debt holders are concerned with the company’s growth and profitability, apart from getting returns.
|It is not possible that the company is defaulting on Senior debt and not on Junior debt.
|The company can default on Junior debt and not default on Senior debt; this can be very much possible.
|It is arduous for small businesses or startups to avail of Senior Debt due to a lack of collateral.
|Small businesses generally get, Junior debt instead of Senior debt as they don’t have any collateral.
|Generally, Senior debt holders are Banks or financial institutions, etc.
|Generally, Junior debt holders are the parent company of the company, shareholders of the company or the general public, etc.
|Mostly large banks provide Senior debt with collateral security to large organizations.
|Generally, small banks with no collateral security provide Junior debt to smaller organizations.
|A senior Debt Covenant is an agreement that is signed by the borrower and the Senior Debt holder to make sure the borrower maintains credibility.
|Junior Debt may or may not have any kind of covenant.
|Senior Unsecured debts are even paid before the Junior debt.
|Payment of Junior debt takes place only after the payment of Unsecured and Secured Senior Debt.
|Senior Debt holders have a very low chance of losing money.
|Junior debt holders have a very high chance of losing money. They can even lose the whole principal amount if things go wrong.
These differences are non-exhaustive in nature.
Senior Debt and Subordinated Debt are long-term sources of debt finance serving different purposes. It would be absolutely wrong to say, one debt is more important than the other. For the borrower and the lender, it serves different purposes and is equally important. Borrowers, according to their requirements, and lenders, according to their risk appetite, can select the type of debt.