From lenders to brokers and clients, everyone wants to move transactions along as swiftly and efficiently as possible. Challenges and slowdowns can prevent our desired end goal, of course, but there are resources these entities can draw on to bridge capital gaps and manage your balance sheet accordingly, with the most prominent being subordinate funding.
Second-tier debt allows the senior lender or asset-based lender (ABL) to remain whole whenever taking on or moving a facility. It benefits all parties: Financial losses are eliminated for the senior lender, the client can cover their liabilities, and the subordinated lender can profit from the transaction. Most importantly, their involvement serves as the missing puzzle piece for deadlocked transactions and can serve as an invaluable benefit for ABLs, senior lenders and their clients.
Efficient Balance Sheet Management
Your formula is your formula. If a client no longer fits the bigger picture, you’ll move that facility from your balance sheet to free up resources for other investments. The client, having a date when they have to pay off their facility in full, will start making the necessary preparations to honor their agreement, but the process becomes a lot more complicated if the client can’t come up with the funds to make their senior lender whole.
If there’s a capital gap or a covenant is popped, the transaction can complicate your balance sheet for far longer than anticipated. Seeking to avoid a financial loss and move the transaction along, many ABLs and senior lenders turn to subordinate funds in these situations.
Subordinate funds can fill the capital void, finalize the transaction, and move the facility that’s no longer in the formula. Without a subordinate lender, the client will need to find a capital source to cover their gap and make their senior lender whole, which can take time, especially if their senior lender or ABL is unwilling to extend an over advance. The second-tier lender enters the situation to move the transaction forward, allowing all parties to reach their ideal outcome and advance to the next deal.
This also applies to situations where a client breaches a contract or agreement. The senior lender or ABL would need to move that client’s facility as soon as possible, but, in most cases, the client won’t have enough to cover their outstanding liability within a short time frame. Rather than wait for the client, take a financial loss, or take on unwanted risk, the owner of the client’s facility can quickly streamline the transaction by calling upon a subordinate lender to provide second-tier debt, cover the capital gap and finalize the transaction.
Finalize More Transactions
On the opposite side, the client who’s had their facility moved will have to cover their outstanding balance before the date set by their senior lender. Once they do, they’ll need to search elsewhere for a new home for their facility – and fast.
Most clients need to do this quickly to avoid slowdowns in their business. They will speak with other ABLs and senior lenders to find a new facility that fits their needs, but the offered terms often have to match or exceed that of the old facility. If it’s less than that, the client likely won’t work with that specific ABL or lender, and no transaction will occur.
For example, a client leaving a $5 million credit facility will likely seek another $5 million+ facility at an alternative senior lender or ABL. In most cases, they’ve become accustomed to operating with that resource behind them, and moving forward without it can potentially cause friction within the business, whether financial or operational.
It’s in the best interest of both the ABL and the client to negotiate a solution that satisfies both parties. The client wants to open their new facility as soon as possible, and the ABL wants to work with the client for their own financial benefits. Still, if a capital gap is preventing an agreement, there’s no possibility of either side reaching their desired outcome at that moment.
Subordinate debt exists for this purpose. Instead of both parties walking away from the table without an agreement, a subordinate lender can enter the transaction, bridge the capital gap, and accelerate the transaction. The only caveat is that the senior lender has the right to remain whole, so the subordinate lender is technically taking on an elevated risk.
Accelerate Every Transaction
Closing a deal is an art form. Each party will need to bring the right tools to the table in order to move the transaction forward, but, as we know, it’s not always that simple. Not every borrower has the cash flow to support a transfer of their facility, and not every ABL or senior lender can provide the exact funding that each client needs to do business.
Even if they can, there are situations where capital gaps or breached contracts interfere with the desired end goal, but subordinate lenders can provide the funds necessary to bring the deal across the finish line. Subordinate lenders can be that solution and forming a relationship with one can be an advantageous investment for both lenders and their clients.