RESOURCES
Senior Term Debt
Typically 50 percent to 70 percent of a firm's capital structure is comprised of senior debt. Senior debt is collateralized by a first lien on the current and long-term assets of the company. It is generally provided by banks and other financial institutions that make business loans, although senior debt can also come from a private placement to institutional investors or via a public bond issuance.
Amount
The amount of senior term debt typically provided to a company depends on the type and quality of its collateral and the stability of its cash flows. A senior lender's first priority is to analyze the value of the assets. Generally the company's current assets are already claimed by a revolving line of credit; senior term debt will usually be collateralized by a company's fixed assets. The amount of the term loan will be based on a formula that applies an advance rate to the assets in order to determine the amount that may be borrowed. Advance rates depend on the type, age and quality of the assets. Typical advance rates are 60 percent to 85 percent of the appraised fair market value of the land and buildings and 40 percent to 90 percent of the orderly liquidation value of the machinery and equipment.
The amount of senior term debt advanced at closing is further limited by the predictability of the company's cash flow to service that debt. If the company has stable cash flows, the lender may provide additional funds above the collateral coverage. Lenders consider earnings before interest, taxes, depreciation and amortization (EBITDA) as a proxy for the company's cash flow, and will lend up to a certain multiple of EBITDA. This multiple will vary greatly between industries and is dependent on the company's health and competitive position. For purposes of performing a preliminary analysis, three times EBITDA is a median multiple for senior term debt.
Term and Amortization
Senior term debt typically amortizes over four to seven years. Payments are generally made monthly or quarterly, but the amortization schedule can vary to conform to the company's stream of cash flows. Some lenders are willing to forego amortization payments for a number of years and allow the loan to be repaid in one or a few large payments. Typically, the longer the time to repayment, the higher the interest rate.
A lender may also impose a prepayment penalty, if a borrower repays the business loan ahead of schedule. These penalties are often a percentage of the amount prepaid.
Price
Interest rates on senior debt range from 0.25 percent under prime to 5 percent over. Depending on the perceived risk of the company's cash flow and the quality and quantity of the collateral, interest rates for senior term debt may be either fixed or floating. A lender will occasionally tie the interest rate to a grid, so that as a company becomes less leveraged and less risky, the interest rate on the debt decreases.
Security
Senior debt has a prior claim over subordinated debt with respect to collateral value and cash flows. The senior lender applies advance rates to ensure that the loan amount is less than the quick sale value of the assets. In order to maintain this level of security, most lenders require monthly or quarterly asset audits to ensure that the value of the collateral is not deteriorating.
Financial Covenants
A lender uses covenants to exert control over the borrower in order to protect a business loan. Senior debt that is repaid from cash flow will often require financial covenants. Covenants are designed to keep the company within certain financial parameters. For example, the lender may want the company to stay below a certain ratio of debt to cash flow and to stay above a certain ratio of cash flow to interest. Breaking a covenant may put the company in default.
Typical financial covenants associated with a term loan may include:
- Senior Debt / EBITDA
- EBITDA / Senior Interest
- (EBITDA - CapEx - cash taxes) / (cash interest + debt amortization) known as "fixed charge coverage."
