Senior Debt vs. Subordinated Debt
Senior debt refers to debt that is in first-lien position. In the event of a default and subsequent liquidation, the senior lender (often a commercial bank), has first priority in recouping its investment. When a company goes bankrupt, stake holders divide the proceeds from selling the company’s assets. The senior lender is first to be re-paid, followed by the subordinated debt holders, followed by equity holders. Because senior debt’s first priority repayment presents a lower-risk position compared to subordinated debt or equity investors, the senior debt is expected to have more favorable interest rates associated with it, commensurate with the lower risk assumed.
Subordinated debt, also known as mezzanine or junior debt is a second-level of debt. Such debt is referred to as subordinate, because the debt providers (lenders) have subordinate status in relationship to the senior debt. Because of this, subordinated debt is a higher-risk investment for the lender and therefore commands is a higher interest rate. Further, mezzanine debt often carries equity components with it such as warrants or other convertible securities that provide an option for the debt holder to convert the debt into equity within a specified time frame.