RESOURCES

Subordinated Mezzanine Debt

Between 15 percent and 30 percent of buyout financing is typically comprised of subordinated debt. This debt is subordinate to senior debt, giving it a second claim on a company's assets. Subordinated debt financing is generally provided from insurance companies, finance companies and subordinated debt funds. Alternatively, it is raised with public offerings of high-yield - or "junk" - bonds sold to insurance companies, pension funds, and other institutional investors. Governments or other public entities may also be a source of subordinated debt, usually on much better terms than capital market sources. Subordinated debt terms are typically six to ten years, and principal payments are commonly deferred until after senior debt is retired.

Subordinated debt is lent based on the amount and predictability of cash flow required to service senior debt. Interest costs can be anywhere from two to eight percentage points more than senior debt. Because subordinated debt usually has little collateral protection, the lender may request warrants convertible into the company's equity. The warrants typically represent an amount of between 1 percent and 10 percent of the company's outstanding stock.

American Capital's providers typically make subordinated loans ranging in size from $1 million to $10 million, with terms ranging from five to ten years. These loans are secured by a second lien on property, plant and equipment. Principal amortization can be deferred during the first four to five years to conform to a business' cash flow constraints. Interest on these facilities can be fixed or variable, with rates depending upon the company's credit situation and the structural features of the loan.

Subordinated loans are provided to meet a number of corporate objectives, such as:

Refinance Existing Debt

A subordinated loan can be used to increase the available balance secured by a second security position on the firm's assets, to meet balloon payment obligations or to secure lower current interest rates.

Support of a Broader Financing Package

A subordinated loan can be used as part of a broader financing package of debt and equity to complete a management or employee buyout or finance a turnaround.