Question: My bank has requested that I subordinate a $75,000 loan that I’ve made to my business. Would you please explain this to me?
Answer: Subordinated debt is a debt obligation that is subordinate (or second-in-line) to another creditor. Your bank appears to want your loan to be second to theirs; it wants the loan that it makes to your business to be paid off in full before you pay off the loan you’ve made to your business.
Your bank might allow your business to make some payments to you during the term of the bank loan, but it likely wants to be able to approve them and, if necessary, prohibit them – such as if your business begins to experience financial trouble. By granting a subordination you are also agreeing that in a liquidation scenario the bank loan will be paid before you get repaid. That is, the bank will have a position that is superior to yours.
Although this is very common, it is a material loan term that could have a real financial impact on you. Give it some thought before you agree to the condition.
This article was written by the experts at The Business Owner. If you are the owner of a private business, go to www.TheBusinessOwner.com or call us at (800) 634-0605 for more no-nonsense how-to information.
This article originally appeared in The Business Owner Journal, the periodical of choice for owners of small and midsize private businesses. All rights reserved, D.L. Perkins LLC. © 2012.
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