Junior Debt

Junior debt is debt that is repaid only after senior debt in a serious case. Because lenders bear this higher risk, they require a higher interest rate. It fills the gap between safer senior debt and equity. Subordination is created contractually in an intercreditor agreement, which governs not only payment ranking but also the distribution of enforcement proceeds and standstill periods for junior creditors.

In return for the higher risk, interest is agreed well above senior debt levels, often split between a cash-pay portion and a deferred portion added to principal, which preserves the company's liquidity in the early years. Warrants or equity options are sometimes added, letting lenders share in value creation. Typical forms are mezzanine capital, second lien loans, vendor loans and shareholder loans. The layer is used where senior debt capacity is exhausted but the equity contribution is to be kept limited, for example in buyouts, in platform add-on acquisitions or in mid-market succession solutions.

The economic trade-off is clear: junior capital is more expensive than bank debt but cheaper than equity and does not dilute ownership. For shareholder loans it should be noted that they rank behind other claims by law in insolvency. Beyond the interest rate, the borrower's decisive question is what intervention rights the junior lender actually has, because some providers remain largely silent while others require consent rights, reporting duties and a board seat. Early repayment also needs settling, since junior capital is the most expensive element of the structure and a company will want to repay it as soon as possible after successful development. Staggered prepayment penalties declining over the term are customary.

Note: This explanation is for general information only and does not constitute legal advice. The legal position depends on the individual case and may change with new legislation or case law. For a binding assessment, please consult a qualified lawyer.