What is a subordinated debt?

Subordinated debt refers to the debt owed to an unsecured creditor. In the event of the bankruptcy or liquidation of the debtor, the court will prioritize the outstanding loans which the liquidated assets shall repay. Therefore, subordinated debt can only be paid if any assets left after the claims of secured creditors have been met. Hence, these types of debt with lesser priority make the grade as subordinated debt. In financial parlance, subordinated debt is also known as subordinated loan, subordinated bond, subordinated debenture or junior debt.

The main reason a company going for subordinated debt is that it allows the company a way to raise additional capital after all lines of credit and other resources have been exhausted. Further, issuance of subordinate debts like subordinated loan, subordinated bond, and subordinated debenture has advantage over acquiring money through issuance of equity shares as subordinate debt does not dilute the stake of promoter’s shareholding. In addition, it is a more tax-effective instrument, as interest paid is tax-deductible whereas dividends paid do not get such tax benefit. However, in view of bigger risk associated with subordinated debt, it is important for lenders of subordinate debt to consider a loan applicant’s solvency as well as other loan obligations in order to evaluate the risk should the entity be forced to liquidate.