3 questions to smart minds
Photo: M. Mathieu

Subordinated loans as an instrument for SME financing

For this 3 questions to Matthias M. Mathieu

Photo: M. Mathieu
1. Octo­ber 2014

In the course of risk-orien­­ted lending by banks through Basel II, the focus is on the credit­wort­hi­ness of a company. Subor­di­na­ted loans fulfill an equity-rela­­ted func­tion. This can result in a higher over­all credit rating for the company. Subor­di­na­ted loans are loans that are subor­di­na­ted to other payment obli­ga­ti­ons. In the context of a liqui­da­tion of the company’s assets, they ther­e­fore come after all bank and supplier liabi­li­ties in the order of priority. 

Here are 3 ques­ti­ons for Bright Capi­tal, a fund and asset manage­ment company with a focus on debt invest­ments. The company grants subor­di­na­ted loans to medium-sized compa­nies with sales of 10–200 million euros and to real estate projects with a mini­mum finan­cing volume of 5 million euros.

For this 3 ques­ti­ons to Foun­ding part­ner at BRIGHT CAPITAL in Frankfurt

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.

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