Senior Debt - Explained
What is a Senior Debt?
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Table of ContentsWhat is Senior Debt?How Does Senior Debt Work?Secured and Unsecured Senior DebtSenior and Subordinated DebtExample of Senior Debt
What is Senior Debt?
In finance, a debt that takes priority over other debts is a senior debt. This type of debt must be fully paid before other subordinated or junior debts are paid. In the event of a company going out of business, a senior debt must be repaid in full first, senior creditors have leverage over other creditors. Generally, senior debts are more secured and take precedence over other forms of debt. Banks are mostly the issuers of senior debt, lenders of senior debts are repaid fully before junior debts are considered. Bondholders are also examples of issuers of senior debt.
How Does Senior Debt Work?
Senior debt is otherwise called senior note, it is the first debt a company repays in the event of folding up or going bankrupt. This form of debt has first claims on the finances of a company before other junior debts. Also, in the categorization of a company's liabilities, senior debt has precedence over other debts as it is the first tier of liability. Senior debts are secured debts backed by a collateral that can be converted into cash in the event of a company going bankrupt or folding up. Senior debts carry less risks than other debts such as subordinated or junior debts. When a company goes bankrupt, there is the tendency that it will be unable to pay all creditors, in this situation, the creditor of a senior debt is paid first.
Secured and Unsecured Senior Debt
There are two categories of senior debts, these are;
- Secured senior debt: A secured senior debt is backed by collateral in the form of assets or properties. If the borrower goes into default, such collateral can be liquidated to repay the creditor.
- Unsecured senior debt: An unsecured senior debt is the direct opposite of the secured debt, it is not backed by collateral. This type of debt holds claims against the general assets that a company owes and not on a specific asset.
Senior and Subordinated Debt
Senior debt can also be discussed in relation to a subordinated debt. A senior debt is given priority over a subordinated debt as it comes first when it comes to claims for repayment. All other debts different from a senior debt are subordinated debts which are otherwise called junior debts. Subordinated debts are not settled unless senior debts are paid in full first, this means that if after paying senior debts in full, the company has no assets to pay other debts, subordinated debts might remain unpaid. Hence, subordinated creditors are often exposed to the risk of losing out when it comes to debt settlement.
Example of Senior Debt
Here is an example of senior debt: If company XYZ owes Back A a sum of $500,000 which is collateralized by the assets of the company and takes another small loans from other lenders without the use of collateral. The debt from the bank is the senior debt while other debts are subordinated or junior debt. At the event of bankruptcy or insolvency of Company XYZ, the assets of the company are liquidated for the purpose of repayment of debts. The bank loan, which is the first tier liability of the company is the senior debt and is repaid in full before all other debts are given consideration.