Oct 3, 2023

Senior Debt

Arc Team

Go-To-Market

If you’re in the process of evaluating senior debt for your next raise, there are some things that you should know. In this comprehensive guide, we dive deep into the ins and outs of senior debt— what makes it “senior”, the qualifications for raising capital via this form of startup financing, and how it compares to other forms of financing. We also look at the pros and cons of senior debt and cover the top providers of senior debt. Let’s dig in!

What is Senior Debt?

Senior debt, also known as senior notes or senior loans, is a form of debt financing that allows startups to raise capital from lenders such as banks, private equity funds, venture capital firms, and other financial institutions. The financing can be securitized or unsecured and is typically issued in the form of notes or bonds. The most important thing to acknowledge about this form of startup financing is that it is considered “senior” to other forms of debt, meaning that it is given the highest priority when it comes to repayment. If the company goes bankrupt, senior debt holders are repaid before other creditors, making it a safer option for lenders and investors.

What makes debt “senior”?

The term ‘senior’, in “senior debt” refers to the repayment priority that is given to holders of this form of debt financing. The seniority of debt is determined by the order in which debt is taken on, the associated terms, and collateralization (or lack thereof). Debt that is taken on first and is securitized is typically considered senior debt, and debt that is taken on later is considered junior debt or ‘subordinated debt’, though this is not always the case.

What are the qualifications for raising capital via senior debt?

Raising capital via senior debt is not an easy task, and certain qualifications must be met for a company to be eligible. Typically to raise capital from this form of debt financing, startups must have recently raised a round from equity financing. The accessible amount is typically capped at 30-50% of the equity raise, such is the case with venture debt. Outside of the recent raise requirement, startups may also be required to demonstrate positive financial performance and a history of on-time repayments. Also, occasionally the founders of a startup will be required to personally guarantee the loan, and the startup will need to put up their assets as collateral.

What do startups use senior debt for?

Startups use senior debt for a variety of purposes, including:

Finance growth and expansion
Finance acquisitions
Refinance existing debt
Fund research and product development
Purchase equipment and other assets

Senior debt may also be used to satisfy working capital needs, such as payroll and other operational costs, as well as large-scale marketing and advertising campaigns.

How much capital can startups raise from senior debt?

The amount of capital that can be raised from senior debt depends on a variety of factors, including the amount of capital the startup has raised, the amount of collateral or assets the company has, and any other outstanding debt the company has on its balance sheet. Generally speaking, the amount of capital that can be raised from this form of startup financing is usually greater than the amount of capital that can be raised from subordinated debt, but less than the amount that can be raised from equity financing.

What are the common features of senior debt?

The common features of senior debt are:

Fixed interest rate – this form of startup financing typically has a fixed interest rate, which means that the rate of interest charged on the loan balance isn’t changed during the term.
Fixed repayment schedule or bullet structure – this form of startup financing typically has either a fixed repayment schedule with fixed monthly principal and interest payments or a bullet structure with no required payments until maturity when the entire balance is due.
Secured by collateral – this form of startup financing is usually secured by assets or collateral, which gives lenders and investors greater protection in the event of a default.
Priority repayment – this form of startup financing is considered a higher priority than other forms of debt and is paid back first in the event of default.

What are the common types of senior debt?

The most common types of senior debt are senior unsecured notes, senior secured notes, and senior secured private debt.

Senior unsecured notes, a.k.a. “unsecured senior debt” or “unsecured debt”, are loans that do not require any collateral or security and are typically issued by investors or lenders.
Senior secured notes, a.k.a. “secured senior debt” or “secured debt”, are loans that require collateral or security and are typically issued by banks or other financial institutions.
Senior secured private debt is debt that is issued privately and is typically used by startups to bridge the gap until their next equity raise.

Compared: Senior Debt vs Subordinated Debt

Senior debt (senior notes) and subordinated debt are two different types of debt that are commonly used by startups to raise capital. The main differences include:

Priority of repayment – senior notes are considered a higher priority than subordinated debt and is repaid first in the event of a default.
Securitization or collateral – senior notes are usually secured by assets or collateral, while subordinated debt is unsecured.
Interest rate – senior notes typically have a fixed interest rate, while subordinated debt has a variable interest rate.

Compared: Senior Debt vs Venture Debt

Senior debt (senior notes) and venture debt are two different types of financing that are commonly used by startups to raise capital. The main differences include:

Repayment – senior notes are typically repaid in installments over a set period, while venture debt is typically structured as a bullet and is repaid in a lump sum.
Interest rate – senior notes have a fixed interest rate, while venture debt may have a variable interest rate.
Securitization or collateral – senior notes are usually secured by assets or collateral, while venture debt is usually unsecured.
Dilution – S.D. is usually non-dilutive, whereas venture debt typically comes with warrants that make it dilutive.

Compared: Senior Debt vs Revenue Based Financing

Senior debt (senior notes) and revenue based financing are two different types of financing that are commonly used by startups to raise capital. The main differences include:

Repayment – senior notes are typically repaid in fixed installments over a set period, while revenue based financing may have a fixed repayment structure or a variable repayment structure based on monthly revenues. If based on monthly revenues, the rate is fixed but the amount repaid varies. In high-revenue months, the amount repaid is higher than in low-revenue months.
Securitization or collateral – senior notes are usually secured by assets or collateral, while revenue based financing is typically not secured, or if secured, is only secured by the company’s revenue.

Compared: Senior Debt vs Equity Financing

Senior debt (senior notes) and equity financing are two different types of financing that are commonly used by startups to raise capital. The main differences include:

Dilution – senior notes do not require the startup to give up any equity in the company, while equity financing requires the company to give up some equity.
Interest rate – senior notes typically have a fixed interest rate, while equity financing typically has no interest rate.
Securitization or collateral – senior notes are usually secured by assets or collateral, while equity financing is unsecured.
Repayment – The principal and interest from senior notes are repaid each month, while the principal from equity financing is not directly repaid.

Compared: Senior Debt vs Mezzanine Financing

Senior debt (senior notes) and mezzanine financing are two different types of financing that are commonly used by startups to raise capital. The main differences include:

Dilution – senior notes do not require the startup to give up any equity in the company, while mezzanine financing requires the company to give up some equity.
Interest rate – senior notes typically have a fixed interest rate, while mezzanine finanzing may sometimes come with a variable interest rate.
Securitization or collateral – senior notes are usually secured by assets or collateral, while mezzanine financing is usually unsecured.

What are the benefits of raising capital via senior debt?

There are a few advantages of raising capital via senior debt, including:

Access to capital – Senior debt provides startups with access to a higher level of capital than forms of financing, such as subordinated debt or revenue based financing.
Fixed interest rate – Senior debt typically has a fixed interest rate, whereas other forms of financing may come with a variable interest rate.
Long repayment terms – Senior debt typically has longer repayment terms than other forms of financing, which can be more beneficial for long-term capital needs.
Non-dilutive – Senior debt is not dilutive, whereas other forms of financing are dilutive.

What are the drawbacks of raising capital via senior debt?

There are a few disadvantages to raising capital via senior debt, including:

Higher interest rates – Senior debt typically has higher interest rates than other forms of financing, such as venture debt or mezzanine financing.
Prepayment penalties – Most senior debt loans come with prepayment penalties, which can be costly.
Securitization – In the event of default, lenders who hold senior debt are repaid first, even before the founders and other investors.
Limited flexibility – Senior debt typically comes with restrictions around the use of funds and requirements for financial performance. If not complied with, the startup may be subject to streamline triggers which enables lenders to recall outstanding balances prematurely.

Final thoughts on raising capital via senior debt

Raising capital via senior debt can be a great option for startups with long-term needs and those that have recently raised equity capital. It comes with fixed interest rates, long term repayment schedules and is non-dilutive, which can be beneficial for limiting the overall cost of capital. However, it can also be very heavy, which means its uses are limited, it may come with high-interest rates, and in the event of default will result in a smaller payout for the founders and investors.

If you’re in the process of evaluating senior debt, check out revenue based financing, which is more lightweight, is not securitized, and can be accessed more quickly (less than 48hrs). Alternatively, if you'd like help raising senior debt, get in touch!