Senior debt

Every funding arrangement has an order of who gets paid back first. Senior debt is at the top. If the business, the building or the development is sold under pressure, the senior lender takes its money out before anyone else sees a dollar. That front-of-the-queue seat is what makes it the lowest-cost layer of finance.

The capital stack, top to bottom

Lenders and investors often picture a deal as a stack of funding layers. The higher the layer, the safer it is and the less it costs.

Layer	Typical security	Risk to the funder	Relative cost
Senior debt	First mortgage or first-ranking GSA	Lowest	Cheapest
Mezzanine or subordinated debt	Second mortgage or second-ranking security	Higher	More expensive
Vendor finance or shareholder loans	Often unsecured or subordinated	Higher again	Varies
Owner equity	None; owners get what’s left	Highest	No interest, but first to absorb losses

Owners rarely use the phrase “senior debt” for an everyday business loan, but the idea applies to them. If your bank holds a first mortgage over your factory, that loan is senior to any second mortgage behind it and to any unsecured creditors.

What decides the ranking?

For land, it’s mostly the order mortgages are registered at the state land registry. For other assets, it’s generally the order security interests are perfected on the PPSR.

Lenders can rearrange the default order by contract. A subordination or priority deed records that one lender agrees to rank behind another, often up to a capped dollar figure. In bigger deals an intercreditor deed also sets out who can enforce, and when. These documents are standard in mezzanine finance, development funding and business purchases.

Senior doesn’t always mean untouchable

ASIC’s liquidation guide explains that secured creditors can appoint a receiver and continue enforcing even after a liquidator is appointed, which shows how strong the senior position is. But there’s an important exception. Under section 561 of the Corporations Act, if a company’s unsecured assets can’t cover certain employee entitlements, those entitlements are paid from circulating assets, such as stock and receivables, ahead of the lender holding security over them. Senior lenders who rely heavily on stock and debtors build this into how much they’ll advance.

Worked example: buying a business

Say someone is acquiring an Adelaide electrical wholesaler for $2.4m. The funding comes in three layers:

• Senior: a bank lends $1.4m secured by a first-ranking GSA over the business and a first mortgage over the buyer’s investment property.
• Subordinated: the vendor accepts $400k of the price over three years, signing a deed that ranks this behind the bank.
• Equity: the buyer contributes $600k of their own cash.

Three years in, a major customer collapses and the business has to be sold for $1.7m. The bank recovers its remaining balance first. The vendor is paid next from whatever’s left. The buyer’s equity absorbs the rest of the loss. Senior debt was cheapest precisely because this is how a bad outcome plays out. For more on structuring a purchase, see business acquisition loans. A brief enquiry is the quickest way to test a structure like this.

Related terms

Mezzanine debt, first mortgage, secured creditor, unsecured creditor and gearing.

Putting together a layered deal?

Whether it’s an acquisition, a property development or growth funding that needs more than a bank will lend on its own, getting the senior layer right shapes everything sitting behind it.

Share the outline with us. It’s about a minute of typing, and an enquiry doesn’t set off a credit check. We don’t broadcast your deal to every lender in the country. A person here reviews the structure and calls you to discuss realistic senior and secondary options. The more exact your figures on price, deposit and existing debt, the better our first suggestion will be.

Talk to us about your funding stack →