Senior debt instruments provide financing, take primary security against either specific or all assets of the borrower, have fixed terms of repayment, and charge fixed or floating interest rates. As a general rule, senior debt lenders are relatively risk adverse and the market is composed primarily of large commercial banks and insurance companies. Knowing what lenders expect can be key to planning and negotiating a successful deal.

In evaluating a transaction, senior debt lenders need to see a substantial cushion between their loan value and the company's value. In an ideal financing arrangement, the senior lender would like to be fully secured by tangible assets such as accounts receivable, inventories, and real estate. Few deals meet this collateral test and, therefore, senior lenders rarely finance loans greater than 70 percent of a company's value.

In general, there are two broad categories of senior debt financing loans--asset-based and cash-flow-based loans. Lenders making asset-based loans focus primarily on the nature of the assets securing the loan. These can be accounts receivable, inventory, or fixed assets such as machinery, equipment, and real estate. The level of loan advanced is related to the amount of collateral available. Cash flow loans, however, are those in which lenders primarily rely on the cash-generating ability of a business rather than on particular assets for repayment. Although assets can also secure these loans, the loan amounts and repayment schedule are more closely related to operating cash-flow capability of a company. Here a lender's expectation is that he will be repaid out of cash flow rather than out of a forced liquidation of the underlying collateral.

Senior loans are often revolving in nature with lenders willing to increase the loan amount if cash flow or the value of the assets securing the loan increase.

October 2000

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