What is Senior Debt?
Senior debt is debt that is first to be repaid, ahead of all other lenders or creditors, in the event of a borrower’s bankruptcy.
How Does Senior Debt Work?
For example, if Company XYZ issues bonds, the bondholders are creditors who are senior to Company XYZ's shareholders, for example. This means that should Company XYZ go bankrupt, the bondholders are entitled to repayment before the shareholders are.
Let’s say that Company XYZ needs more capital now, and so it borrows money from Bank ABC. Who gets paid first now? The bondholders or Company XYZ? [Bank ABC, you mean?] It depends on what Company XYZ negotiates with Bank ABC, but it is likely that Bank ABC is subordinate to the bondholders, meaning that if Company XYZ goes belly up, the bondholders get paid first, then Bank ABC, then the shareholders (if there’s anything left).
Why Does Senior Debt Matter?
Senior lenders get their hands on leftover cash first in the event of bankruptcy. Accordingly, subordinated lenders (those lenders further down in the pecking order) are more likely to get stiffed. This is why some lenders might require senior status in order to make a loan (meaning that they must be first in line). In our example, Bank ABC may charge a higher interest rate on the loan because of its subordinated status and thus added risk of not being able to get its hands on any of the scraps if Company XYZ goes bankrupt.