What Does Subordinated Debt Mean?
Subordinated debt is a class of debt whose holders have a claim on the company's assets only after the senior debtholders' claims have been satisfied. Subordinated debt offers investors a risk/return profile above that of senior debt, but below the risk/return profile of pure equity.
Divestopedia Explains Subordinated Debt
Subordinated debt can be used for growth capital, acquisitions, recapitalizations, and management and leveraged buyouts. This type of debt usually carries an interest rate between 13% and 25%, and may include equity kickers to further compensate the holders for the additional risk and lack of asset security.
Subordinated debt can be a good way for private company owners to obtain growth capital, since the dilutive effect on their company ownership can be minimized despite the equity kickers. Subordinated debt holders need to ensure there is enough free cash flow to service the debt, since the debt is either unsecured or partially secured. Therefore, despite the high interest rate on subordinated debt, if the business is flowing good and consistent free cash flow, it may be best to obtain subordinated debt rather than a pure equity injection.