Subordinated debt is any form of financing whose repayment is contractually junior to senior (or superior) debt — in default or liquidation, subordinated creditors are repaid only after all senior creditors have been fully satisfied. Subordination may be contractual (defined in an intercreditor agreement) or structural (the debt is issued at a holding level above the entity that carries the senior debt). Subordinated debt occupies the structural and economic middle ground between senior debt and equity: it bears higher risk than senior debt and demands higher compensation, but provides more downside protection than equity.

In Franco-Swiss LBO and growth financing structures, the most common forms of subordinated debt are: mezzanine debt (with or without equity warrants or PIK interest), shareholder loans (quasi-equity from PE sponsors), high yield bonds (for larger transactions), and PIK notes (Payment in Kind). The cost of subordinated debt in European mid-market LBOs typically ranges from SARON/EURIBOR + 8% to +15%, potentially including a PIK component (interest capitalized rather than paid in cash) and an equity warrant.

In a due diligence, subordinated debt — particularly shareholder loans — must be carefully classified in the enterprise-to-equity bridge: if the loan is expected to be repaid at closing, it is a debt-like item reducing equity value; if it has the characteristics of quasi-equity (long maturity, subordinated, interest roll-up) and will remain in the structure post-acquisition, it may be treated differently. The distinction is commercially significant and frequently contested.

At Hectelion, we structure and analyze subordinated debt instruments in our LBO structuring and due diligence mandates.