Subordinated Debt . . .

is borrowed money that stands to be repaid after other debts but before company shareholders receive consideration in the event the company is liquidated. Subordinated debt is frequently used in venture financings to provide investors with a way to increase their return on investment or to withdraw a portion of it as debt repayment without unduly prejudicing the company’s ability to obtain other borrowings.

Since it stands behind other debt if the company liquidates, subordinated debt is often treated as equity by other lenders. That is, lenders are willing to extend additional credit to the company as if the debt did not exist, as long as their debt matures and is repaid before the subordinated debt. This usually means that the subordinated debt agreement not only contains specific language subordinating it to other debt but that its maturity date occurs after that of the company’s other debt. Therefore, the later the payback on subordinated debt, the easier it is for a company to borrow additional funds.

Subordinated debt provides a company with cash, usually with a long-term payback, and gives the investor a way to withdraw a portion of his investment without adverse tax consequences. Sometimes subordinated debt contains a convertibility feature that allows the investor to convert it into shares of stock. This gives the investor the flexibility to withdraw his funds as debt repayment or to convert to share ownership if the company’s stock is selling for a good price. See: Cash Flow, Convertible Securities, Debentures, Structure, Subordinated Convertible Debentures.