Senior Debt: Summary of Terms
In addition to the process described in the lesson titled “Lender Engagement,” there are a few additional items to be aware of as you start to evaluate capital structure options. The first is that the capital stack should be approached in order of seniority. To understand why think about a capital structure that combines senior debt, subordinated debt and equity. The protections available to each of the capital sources will vary based on the risk assumed. Senior debt, being the most secure source of capital, will require assurances unavailable to the subordinated lender, but a subordinated lender will find it difficult to provide terms without any knowledge of the senior lender’s expectations.
In the Senior Lender Term Sheet example included as part of this lesson, you will see financial covenants that can impact the subordinated lender. The most obvious is the Total Leverage Ratio, which limits the amount of funded debt as a multiple of EBITDA. The remedies available to the senior lender in the event that this covenant is breached can potentially put all subordinated capital (which in this example includes both the subordinated debt and equity) at risk. Consequently, the subordinated lender will need to know what the senior lender expects.
This dynamic brings me to the next point. Once the sponsor has identified the lender firms they would most like to work with, it is critically important to confirm that these lenders are willing to work together. In addition to drafting the credit agreement for each tranche of debt, legal counsel for the lenders will draft and negotiate what is known as the “intercreditor agreement.” We will provide more information on this document in a future lesson, but for now it is important to note that a strong disagreement on this front late in the process can kill a deal.
Author’s Note: I once worked on a transaction where every item had been negotiated and all documentation was drafted and in final format, but a single number in the Subordination and Intercreditor Agreement nearly caused the entire transaction to fall apart. Had it not been for a partner’s relationship with the c-suite of the senior lender we were working with we would have lost the investment and had to absorb substantial dead deal costs.
Please download the PDF notes for the full lesson.