Subordinated loans as an instrument for SME financing
24. July 2019
Friederich von Hurter and Stefan Saalfrank
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1. What currently makes the alternative financing option of subordinated loans attractive again?
The supervisory rules resulting from the global economic crisis are forcing banks to strengthen their equity and capital ratios. This leads to a more selective choice of borrowers. To obtain a bank senior loan, medium-sized companies have to show a higher level of equity than they did a few years ago. The changed framework conditions mean that entrepreneurs are faced more than ever with the decision of how best to secure financing for their company. Smaller medium-sized companies with sales of no more than 200–300 million euros p.a. are particularly affected. Many of these owner-managed family businesses are not prepared to take a private equity investor on board and are very open to alternative forms of financing, such as subordinated loans. We believe that the market for alternative forms of financing will grow strongly in the coming years.
2. What is the difference between mezzanine financing, subordinated loans and private equity?
The subordinated loan is a classic form of mezzanine financing. Mezzanines can take various forms, such as dormant equity holdings, profit participation rights, participating loans or subordinated loans. Subordinated loans are often not secured and bear a correspondingly higher interest rate in line with the risk. Even though we are currently in a low-interest phase, taking out subordinated loans, for example in order to obtain a senior loan from the bank at market conditions, can be quite interesting in the mixed calculation. — In contrast to (private) equity, mezzanine financing does not require the sale of shares in the company.
3. How do you assess the market? How many companies choose a subordinated loan for their financing compared to other financing options?
It is difficult to say in percentage terms how many companies take up subordinated loans from external investors or add them to their debt capital. Subordinated loans are often also granted by shareholders. Bank loans are the most common financing instrument in German-speaking countries, and this will not change. However, we have seen in the last two years that the relevance of alternative forms of financing is increasing significantly. Compared to the Anglo-Saxon countries, Germany, Austria and also Switzerland have a lot of catching up to do in the field of venture capital, private equity and alternative forms of financing.