Senior debt is the most common form of debt lending in the credit market and holds the most significant share of the market. Investors incorporate senior debt financing to raise capital for potential mergers and acquisitions as well as leveraged buyout (LBO) transactions. The article will present an overview of senior debt that includes its key characteristics as well as the benefits and drawbacks. The implications associated with structuring senior debt will also be discussed.
Senior debt, also known as bank debt financing, is the most senior tranche in a company’s capital structure. Senior bank debt loans are rated as non-investment grade similar to high-yield ratings. As the first layer in the capital structure of a company, senior debt is paid off first during a company’s liquidation since it has a priority claim on the company’s cash flow. Generally, senior debt is amortized over a five to ten-year period and has the lowest rate of return compared to other debt in a capital structure. 
Senior debt loans are granted in tranches such as A, B, C and D tranches. The A tranche is paid off with amortization, while the remaining tranches are paid off with no amortization. A tranches are typically sold to commercial banks, and loans in the B, C and D tranches are usually sold to mutual funds and hedge funds. Senior debt loans have covenant agreements that include a maximum allowable debt/cash flow ratio and minimum coverage of interest priced at LIBOR rate plus 200 to 400 basis points (bps).1 Interest and principal payments are paid by seniority based on the different classes of loans.
Senior debt financing has been beneficial to both investors and senior lenders.
One of the implications of structuring senior debt is that the investors must be willing to forgo further acquisitions for the company. Senior debt loans can be restricted by covenants to prevent further acquisition or additional borrowing. This implies that companies must agree to senior restrictions placed on capital expenditure, dividends and acquisitions. Another implication is that companies that incorporate senior debt in their debt structure must consider the requirement to maintain certain defined financial ratios. Company managers and creditors must monitor the financial ratios of companies to ensure that the company can repay the interest and principal of the senior loan.
Senior debt instruments have been a source of debt financing for many investors. Senior debt loans are characterized by different tranches of loans as well as amortization periods for interest and principal payments. Both senior lenders and investors benefit from senior loans. Senior lenders have access to a company’s assets in the event of a bankruptcy or liquidation, while investors benefit from paying low interest payments to lenders. Senior debt financing can increase the financial burden of a company and place the company under pressure to perform. Investors must consider the restrictive covenant agreements associated with structuring senior debt prior to incorporating this form of debt in the company’s capital structure.
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