Definition
Senior debt is borrowing that ranks first for repayment, usually a bank term loan or asset-based facility secured on the business's assets. If the business fails or is sold, senior lenders are repaid before junior lenders, sellers holding loan notes and shareholders. Because it carries the least risk, it is usually the cheapest source of acquisition finance, and it comes with the strictest conditions, known as covenants.
Worked example
Oldmill Precision Engineering is a fictional UK business bought for £5,000,000.
- A bank lends £2,500,000 as a senior term loan, secured on the business's assets.
- The seller leaves £1,000,000 in the business as vendor finance, ranking behind the bank.
- The buyer invests £1,500,000 of equity.
If the business struggles and has to be sold, the bank is repaid first, then the seller, and the buyer receives whatever is left.
Seller finance is when the seller lends the buyer part of the purchase price, to be repaid with interest after completion. It is also called vendor finance or a seller note.
Why buyers care
The amount of senior debt available sets the shape of the rest of the deal: how much seller finance you need and how much equity you must find.
Senior lenders usually require other lenders, including the seller, to sign a subordination or intercreditor agreement that puts them behind the bank and can stop payments to them if the business misses its targets. Covenants such as minimum debt service coverage and limits on total borrowing against earnings can restrict how you run the business. Borrowing close to the limit means a modest fall in earnings could breach a covenant.
Test repayments against realistic earnings before you commit. The affordability check in Loupe's valuation tool shows debt service coverage for the figures you enter, but a lender will make its own assessment.
Debt service coverage compares the cash a business generates with the loan repayments it must make. Lenders use it to judge whether an acquisition can carry its debt.