First and Second Lien Loans
Written by Bennet Grill for Gaebler Ventures
Trying to get a loan for your business? It is important to understand the different types of debt, whether that be subordinated or unsubordinated, unsecured or secured. This article focuses on first and second lien loans.
A first lien loan is a form of senior debt.
It is a secured form of debt that has first priority in payment in the event of a company's liquification. Remember that secured forms of debt are backed by specific assets of the company, which serve as collateral to the loan.
The direct opposite of a first lien loan is unsubordinated debt -- an unsecured loan without first priority in the repayment schedule.
In between the two is a method of financing designated as second lien. Second lien loans are forms of secured debt--they require backing by a specific asset of a company and they also have priority over subordinated debt and obligations to the common shareholders.
The interesting quality of second lien debt is that the assets pledged as collateral to the loan can be the same or overlap with the assets pledged as collateral to a first lien loan.
While both first lien and second lien loans are forms of senior debt, second lien loans are second in priority to first lien loans in the repayment schedule. Usually, the lenders of second lien debt have already issued first lien debt and often put forth terms regarding the amount of additional assets that can be pledged. Because second lien debt depends on all first lien debt being repaid first, it is valued to carry more risk and therefore is issued with a higher interest rate than first lien debt.
Second lien debt is akin to taking a second mortgage out on a home--while being able to provide additional capital to a business, it is a risky venture because you only have one asset that is backing two securities. If you default on one loan then all of your equity is at risk because the asset backing your first lien loan will be taken as collateral.
While businesses sometimes need the extra injection of capital, you must make sure you are willing to take the risk of taking out a second lien loan. As the entrepreneur running the company, it is your responsibility to make sure that operations go absolutely perfect during the period the company has second lien debt--it is imperative the company does not risk default while its assets are pledged to two different forms of debt.
Bennet Grill is a writer who has a passion for business and finance. He is currently an Economics major at Duke University in North Carolina.
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