Subordinated loan

Introduction

In the financial world, there are a variety of financing instruments that companies can use to raise capital. One of these instruments is the subordinated loan. In this article, we’ll take an in-depth look at the concept of a subordinated loan, why it’s important for startups, and the role it plays in a company’s financing structure.

What is a subordinated loan?

A subordinated loan is a type of loan that ranks after other debts in the order of repayment in the event of liquidation or insolvency of the company. This means that in the event of insolvency, the creditors of the subordinated loan will not be repaid until all other debts of the company that rank higher have been settled.

Features of a subordinated loan

Subordination

As the name suggests, the main feature of a subordinated loan is its subordination to other debts. This means that in the event of insolvency it will be repaid after other debts.

Higher interest rates

Due to the higher risk associated with subordinated loans, lenders typically charge higher interest rates compared to conventional loans.

More flexible conditions

Often, subordinated loans have more flexible terms in terms of repayment and conditions, which can be attractive to startups.

No collateral

In many cases, subordinated loans are made without collateral, meaning that the lender has no claim on certain assets of the company.

Why does a loan have to be subordinated for start-ups?

Protection against insolvency

Start-ups are often high risk and can easily run into financial difficulties. A subordinated loan gives the start-up more flexibility and can prevent the company from being driven into insolvency, as repayment is made only after other debts have been settled.

Attraction of further capital

A subordinated loan can be attractive to other investors and lenders because it strengthens the company’s equity. This can help attract additional capital that is critical to the startup’s growth.

Flexibility

Start-ups often need a flexible financing structure to respond to market changes. Subordinated loans often offer more flexible terms, which can be an advantage for startups.

No disposal of company shares

In contrast to equity financing, start-ups do not have to surrender any company shares when taking out a subordinated loan. This allows founders to retain control of their company.

Risks and considerations

While subordinated loans offer flexibility, they typically come with higher interest costs. Startups need to carefully consider these costs and ensure they are able to make the interest payments.

Potential debt

Taking out a subordinated loan increases the company’s debt. Startups need to make sure they are not over-leveraged, as this can jeopardize their financial stability.

Practical steps for taking out a subordinated loan

Business Plan

Startups considering a subordinated loan should have a solid business plan that clearly outlines their business strategy, financial projections, and planned use of the loan.

Search for lenders

It’s important to look for lenders who have experience funding startups and are willing to make subordinated loans.

Negotiation of the conditions

The terms of the subordinated loan should be carefully negotiated to ensure that they are favorable to the start-up.

Legal advice

It is advisable to seek legal advice to ensure that all aspects of the loan agreement are understood and in the best interest of the startup.

Conclusion

Subordinated debt can be a valuable financing option for startups that need flexibility and capital to grow. While they offer many benefits, they also come with risks. It is important for startups to carefully review the terms and ensure that they are able to meet the obligations that come with a subordinated loan.