Subordinated Loan – Opportunities, Risks & Benefits
The name ‘subordinated loan’ has a negative impact on many people. It sounds like someone is disadvantaged with a subordinated loan. Nothing is less true. It is one of the most popular and flexible loan forms available and you can find them almost everywhere. In 2019 the subordinated loan is more popular than ever. But what is it?
What is a subordinated loan?
When a loan is taken out, clear agreements are made. Even when you are looking for money for your company, you can take out a business loan or take out a business loan. By taking out this loan, you must repay a certain amount, plus interest, of this loan each agreed term. However, strict conditions are often attached to this, which not every entrepreneur can meet. That is why there are other ways to get money. Examples of this are crowdfunding and factoring, but a subordinated loan is also one of the options.
A subordinated loan is a loan in which the provider of the credit, the person issuing the loan, is subordinated to most other creditors in the event of the company’s bankruptcy. This means that this creditor only has to be paid as one of the last ones and therefore most likely sees little or nothing in return from the loan granted. Only the holders of a bond or share still stand behind the provider of this loan.
Another form is the loan. This loan is in fact the same as a subordinated loan and also has the same risks. The difference is that with a loan a middle ground is found between the own capital and the borrowed money.
This subordinated loan has become popular in the credit crisis. In that period it was difficult to get money from the bank as an entrepreneur. An alternative was a subordinated loan.
Am I eligible for a subordinated loan?
As a private individual you are, in most cases, not eligible for a subordinated loan. Loans in this category are often provided by and to companies. Holding companies, investors or business partners are often the providers of a subordinated loan. They do this because it is attractive to them. They can ask a high interest for this. This is because the difference in risk is very large; the provider of a ‘normal loan’ is much more likely to recover (part of) the invested money in the event of bankruptcy.
However, a subordinated loan does not always have to involve large amounts. It may also be that you want to start your own business, or want to take over an existing business, and need a relatively small amount for that. In that case it is possible to apply for ‘venture capital’. This is also referred to as the scheme. This scheme is based on the money from family, friends or acquaintances who want to help you set up your own business. When they decide to lend you money, they get some benefits from this. This way, these people can get an exemption from the return tax. To be eligible for this, a number of rules must be met. For example, the amount that is borrowed must be at least 2,269 euros. In addition, this money must be borrowed before the company is founded and the interest that is settled may not be higher than described in the law. The loan must also be recorded on paper. This contract must be registered with the tax authorities.
Risks of venture capital
As the name ‘venture capital’ already suggests, the provider of a loan requires quite a bit of courage and courage. In some cases the risks are very high. And not only the risks of an loan are an important factor. There are many more things that play a role, for example the sector in which your company operates, the financial perspective and the situation in which your company finds itself. These lenders invest in your company out of trust. This can ensure that you handle the money even more carefully, because you prefer to pay everything back, but unfortunately this offers no certainty.
Venture capital is also a subordinated loan. Although the name is different and the amounts involved are relatively smaller, there is no difference between these two forms of loans. This means that even in the event of an unexpected bankruptcy, these investors will only be the last to turn when it comes to a distribution of money. The English term for venture capital is FFF, which stands for ‘friends, family and fools’. The latter is the person who forgets that the money invested may never be repaid.
Your company is not doing so well and you are experiencing difficult weather. You therefore need an amount of 5,000 euros to keep your head above water. Because the risks for a bank are much too high in this case, you will not receive a normal loan. Your family wants to help you; they put some money together and give you this 5,000 euros as a loan. You pay a substantial interest on this on each agreed term, but this loan makes things a little better. A win-win situation for you and your family. If things eventually go wrong and you run into bankruptcy, the family will most likely not see the 5,000 euros back.
You have dropped your eye on a small business that you would like to take over. You need 10,000 euros for this, but the bank does not want to give you a loan. A vague knowledge has a similar company and sees opportunities to do business with you in the future. He therefore lends you 10,000 euros as a subordinated loan. You pay a substantial interest on this to your knowledge, but if the acquisition does not turn out well and your company goes bankrupt, this knowledge is one of the last in the list of creditors.
Subordinated loan as a bond
A large company often does not have enough venture capital to raise enough money. Not at all when it comes to a distressed company that can only be saved with money from outside. That is why it is also possible for you as an entrepreneur to use bonds as a subordinated loan. These bonds are debt statements from your companies, which you sell to investors. They pay for this, but the recipient receives a reward in exchange for this investment. This reimbursement can consist of interest, variable or fixed. In most cases, bonds have a fixed term, so that you as an entrepreneur are sure that you can dispose of the money borrowed for the entire period. In some ways it looks like a share, but there are differences. For example, a bondholder has no control over your company. This is usually the case with shares.
The principle of a subordinated loan applies to a subordinated bond. You do not have to repay the holders of such a bond until you have redeemed all other loans and bonds. However, this does not mean that it is the turn of the holders of subordinated bonds in the event of bankruptcy. In that case, shareholders will receive their money even later.
The seller of subordinated bonds is not only attractive for you as an entrepreneur, but it can also be profitable for the investor.
What are the advantages?
In the case of venture capital, the investment is often made because you, the entrepreneur who needs money, are familiar. Nevertheless, there are benefits for the investor in all forms of subordinated loans, and therefore also in the loan.
In box three, for example. The lender may deduct his or her investment from the capital in box three for the first eight years after the loan has been granted. The maximum amount of this exemption is 54,223 euros, while most subordinated loans are likely to be lower than this amount.
As a result of the exemption that the lender also receives, the capital gains tax payable will be lower. However, someone will only benefit from this if the existing capacity exceeds the threshold for box three. This threshold currently amounts to 21,139 euros. If the lender has less than 21,139 euros in capital, then this tax benefit when granting a subordinated loan does not apply.
Although there are relatively many risks associated with a subordinated loan, these risks can already be reduced during the term. If, as a debtor, you are unable to meet your payment obligations, there is a good chance that the lender can whistle for the money invested. To prevent this, to a certain extent, it is possible in that case to cancel the subordinated loan and to use it as a personal deduction. However, this must be done within eight years of taking out the loan. The Tax and Customs Administration also requires a decision stating that you, the recipient, are no longer able to repay the claim.
Benefits with an acquisition
A subordinated loan is in many cases not financed under the scheme, simply because the amounts are too large for this. It is also possible that the lender is a party that wants to sell a company. With a subordinated loan in the event of a business transfer, a win-win situation can arise in the most favorable cases.
You may want to sell your business. There are several possible reasons for this. Finding a good acquisition candidate is then an important task. When you have found this person, the question is always whether this person also has the money to actually realize the acquisition. If this is not the case, a subordinated loan can be a good alternative.
An advantage of this is that if you require the takeover candidate to use the full assets, you may not get the price for your company that you had in mind. By offering the buyer a subordinated loan, you usually receive more money for the company.
A subordinated loan in the event of a company takeover can therefore lead to a win-win situation for both the buyer and the seller: the selling party receives a larger amount for the company, while the buyer has to invest less of the equity. However, this construction only has a chance of success if both parties know well with whom they will work.
Security for other creditors
Against a subordinated loan is a high interest rate. This loan form is therefore more expensive for you as an entrepreneur and therefore it is only attractive when other loan forms, such as a business loan or factoring, are no longer possible. Subordinated loans are often used for financing where no collateral is present, such as working capital or expansion plans. Yet it can also bring benefits to the entrepreneur. If you want to make a high and complex financing application, having a subordinated loan may be the deciding factor.
This is called a stack financing. An example of this is the loan: there is collateral, but not enough to cover all risks. That is why a kind of combination with a subordinated loan is made. This is possible because banks and other financial institutions want to do business earlier if you have a subordinated loan. Why? That is quite simple: if your company goes bankrupt, the bank or financial institution, rather than the provider of the subordinated loan, will not take the first blows.
What are the risks?
When you receive a subordinated loan, you can carry out the business that you intended to do. Because there are also advantages to the lender to a subordinated loan, it may seem interesting to both parties. Nevertheless, there are indeed major risks involved. The biggest risks are not for you as an entrepreneur, but for the investor.
Subordinated loans are, in some cases, made by distressed companies. Such a loan is the last resort for this. The money that comes in as a result is then used to bridge a difficult period and perhaps even to prevent a bankruptcy. At that time the investor can demand a high interest rate and therefore earn a lot of money in a short time, but then the company must survive this difficult time.
If this fails and the company goes bankrupt, a bankruptcy trustee is appointed after the bankruptcy has been declared. The chance that the provider of a subordinated loan will still be covered is almost nil. As mentioned earlier, in the event of a bankruptcy, the ‘normal’ creditors such as the Tax Authorities, the banks, suppliers and other creditors are first discussed. Only then is it the turn of the subordinated loan provider, and then there is a good chance that the money is no longer there.