Having been a senior lender most of my career, I recently joined the First West Capital team because I am passionate about helping businesses achieve the next level of growth – which can include making the leap from senior debt financing to junior capital. It’s not that one is better than the other. They both play an important role in financing a business, and, when done well, complement each other and facilitate optimal business results. So, how do you know when your business needs to make the jump to junior capital? (And what is subordinated-debt, anyway?)
Here we’ll take a look at the definitions of senior debt and junior capital, and explore how they can work together to help your business thrive.
Senior debt with a bank or credit union is usually the most readily available and least expensive financing, which may include first mortgage real estate financing, working capital lines of credit and equipment financing. Traditionally, senior debt loans are secured with a charge over assets, including real estate, inventory, accounts receivable and equipment. Some senior lenders are also willing to provide cash-flow loans, however, they’re usually provided only to companies that have a long-term, proven ability to generate stable, positive cash-flows.
Because both cash flow and collateral are required, most senior debt loans are considered safe and sound. Your company’s ability to qualify is determined by past performance and assets, giving senior lenders confidence on return and limiting downside risk. Where this type of lending gets difficult is when you have to invest into your business in order to realize future growth, and you may have little in the way of had proof that profitability will come from the investment. Bottom line, the bank has limits on risk, and that’s where junior capital steps in.
Junior capital can be used when your business is sound, but not necessarily safe – in other words, you’re established or expanding, but don’t have the security or profitability to access additional senior debt. Junior capital can offer another layer of financing when a company’s capital requirements exceed the senior lender’s capacity – usually due to rapid growth, the age or stage of the business, or the nature of the assets available as collateral.
We at First West Capital are cash-flow lenders, and we take on more risk than senior lenders – giving businesses more financial and operational flexibility. Typically, junior capital facilities last for 3-7 years and address a specific funding gap – for example, you’re financing a new market expansion or product, or you want to acquire another business.
In First West Capital terms, junior capital refers to our suite of debt and equity products – subordinated debt, mezzanine financing and equity – to finance growth, acquisitions and transitions. Our solutions sit somewhere between where the banks stop and private equity begins. We work with established, emerging and expanding businesses that are beyond start-up phase.
To qualify your company, the first thing we look at is the strength of your management and leadership team – we believe this is one of the best indicators of success and determines if our partnership will be a good fit. We also want you to have positive cash flow, however, we can lend on strong near-term potential – a powerful tool to help unlock future growth in dynamic, rapidly-growing businesses.
You might be surprised to learn that a lot of our clients are referred to us by senior lenders. Bankers will often recommend like-minded financial partners to clients who need to access the next level of capital beyond what they’re currently able to offer. Strong partnerships between senior lenders and junior capital providers significantly improves the funding process and facilitates trust and stability with the borrower.
So, how does a business pay back multiple lenders? Well, subordinated debt is just another way of saying we take second position. Whenever there is more than one lender, the terms and conditions are outlined in an inter-lender agreement that stipulates and allocates the priorities between them, including who gets repaid first.
Speaking as a former senior lender, I can say that junior capital providers like First West Capital are preferred by senior lenders because of their responsive, partner-focused approach. Businesses should look for lenders who can collaborate with each other – and with you — to make your business stronger.
The different levels of risk (safety and soundness) are what will determine if you need junior capital, or if you can continue to access traditional financing through a bank or credit union. If you don’t check all the boxes for senior lenders, but you operate in a sustainable market, have strong management and positive cash-flow, junior capital is a viable option. If this sounds like you, feel free to reach out. We’ll be happy to brainstorm with you about how your company can access additional capital.