Senior, subordinated, and mezzanine debt describe the order in which lenders are repaid if a borrower defaults. Senior secured lenders are first and usually hold a charge over specific collateral; subordinated and mezzanine lenders are paid only from what is left, which is why their rates are higher. Seniority improves the position in the queue but does not guarantee repayment.
Senior, Subordinated, and Mezzanine Debt: Where a Loan Sits
What Is the Capital Structure of a Business Loan?
The capital structure of a business loan is a concept that illustrates how the different layers of financing that support a business are organized in a particular order in which they can absorb losses.
Priority of claims is the issue that is viable for a lender to consider because, in case of the borrower’s failure to repay the debt and the subsequent realization of the assets, the money is not divided equally. Legal fees and transaction costs are deducted, and the remaining amount is then distributed among the creditors based on their priority. Usually, the procedure happens in the following waterfall.
Realized assets — enforcement costs — certain preferential claims — senior secured debt — subordinated debt — mezzanine debt — equity
Yet, this framework is a general template, and the factual one depends on the documentation surrounding the loan, security documents, and the jurisdiction that considers the legal claims. Overall, the investor should remember the following principle — the higher the position in the structure, the higher the chance of debt recovery in case of the borrower’s default in comparison to the lower-ranked creditors. Still, the returns are not guaranteed.
Senior Debt: First in the Queue
Senior debt is typically the top of the structure, outranking junior forms of borrowing like mezzanine debt. A loan that has senior security would typically combine contractual seniority with security over the specified assets of the borrower.
Security interest may come in various forms, including, but not limited to, pledge, charge, etc. All the forms carry a meaning because, if the borrower fails to meet repayment obligations, the enforcement of the collateral and the repayment structure would also be defined by the form of the security. This way, senior creditors would not solely rely on the borrower’s general assets in case of insolvency.
What does "first charge" mean?
"First charge" generally means that the lender is entitled to the first contractual claim over the specified collateral, provided that the legal and transaction fees, as well as other costs of the enforcement procedure, have been paid. In case another lender exists and owns another claim of the collateral, they will become a second-ranking creditor and will receive reimbursement only after the financial obligations in front of the first charge creditor have been met.
Subordinated and Mezzanine Debt: Higher Rate, Later Payout
Subordinated debt contractually ranks behind senior obligations, as the first priority goes to senior creditors. If the enforcement of the liquidated collateral is able to fully compensate the higher-ranking senior creditors, the amount that is left may be distributed among the subordinated creditors. That is why the chance that a subordinated creditor will receive only partial compensation or no compensation at all is typically higher than that of a senior creditor.
Mezzanine debt has a similar junior position in comparison to the senior creditor's claims. It typically sits between the highest-ranking senior lenders and equity holders who have completely unsecured loans. In a particular lending agreement, mezzanine debt may be completely unsecured, while in another, it may be supported by the security interest that is lower in the ranking than the interest backing senior creditors.
Is mezzanine debt riskier than senior debt?
Yes, in broadly comparable terms, mezzanine debt creditors would typically have a weaker recovery position than a senior creditor. Mezzanine debt, therefore, can typically have a higher interest rate because of a higher degree of risk.
What the Hierarchy Means When a Borrower Stops Paying
The table below summarizes the hierarchy of the creditors.
| Layer | Repayment order | Typical security | Why the rate differs | What the lender risks |
|---|---|---|---|---|
| Senior secured debt | First among lenders, after enforcement costs and certain preferential claims | First-ranking charge or pledge of the collateral | A stronger recovery position supports a lower rate | Collateral may realize below the debt, or costs may reduce recovery |
| Subordinated debt | After senior secured creditors | Unsecured or lower-ranking security | A higher rate compensates for weaker priority | Senior creditors may absorb most available proceeds |
| Mezzanine debt | Junior to senior debt, often alongside or below other subordinated claims | Often unsecured or second-ranking | A higher rate reflects junior position and exposure to loss | Recovery may be very limited |
| Equity | Paid last, after unsecured creditors | No debt security | Potential upside from ownership | Shareholders may receive nothing when liabilities exceed remaining value |
Structures and enforcement orders vary by jurisdiction and by loan agreement. Higher stated rates compensate for a weaker position, not for better borrower quality. Capital is at risk; returns are not guaranteed.
Who gets paid first if a borrower defaults?
If the borrower defaults, the money is distributed to the creditors based on their priority after all the costs, like legal and transaction ones, have been paid. Typically, the waterfall goes like this: senior creditors are paid first, then, if any amount is left afterwards, subordinate creditors and equity investors with unsecured debt come last in the hierarchy. The following illustrative example helps to understand the hierarchy better. Supposedly, a business pledges a collateral with a market value of €1,000,000 to secure the loan, but, at the liquidation, the assets realize only €750,000. Then, enforcement costs deduct €50,000, and the preferential claims deduct an additional €50,000, leaving the creditors with the amount of €650,000 available to reimburse them.
Supposedly, senior creditors have invested €500,000, subordinated debt includes €250,000, and then comes mezzanine debt with €150,000. Effectively, senior secured creditors will be fully repaid based on their highest priority. After that, the remaining €150,000 would be distributed between subordinated creditors, but not completely. Mezzanine debt creditors will receive nothing since there is effectively no money remaining to reimburse them.
Illustrative only. Actual recovery depends on the asset, the market at the time of enforcement, the costs of enforcement, and the applicable insolvency rules.
How to Read the Seniority of a Crowdlending Deal
Seniority changes the order of repayment, not the outcome: enforcement costs are deducted before any lender is paid, and if the collateral realizes less than the debt, even a senior secured lender can lose part of the principal — while a subordinated or mezzanine lender may recover nothing.
To read the seniority of a crowdlending deal, a retail creditor should firstly identify the existing hierarchy of the creditors and the available collateral that backs the loan. Some information that would be useful to the investor includes the type of the collateral, Loan-to-Value (LTV) ratio, the difference of the collateral’s base and liquidation values, the leverage offered by the borrower, and the platform’s credit risk scoring. In order to calculate LTV, the investor may use the following formula:
LTV = Loan Amount / Collateral Value * 100
If the LTV value is lower than 100%, it would mean that the investor has a secured loan and the collateral pledged against it covers the full amount of the loan. If the value is higher, some parts of the loan remain unsecured, providing less buffer for the investor.
Maclear currently emphasizes the use of LTV as a measurement of the value of the collateral against the loan and, likewise, the metric of Debt-to-Equity to assess the potential returns on investment. Likewise, Maclear uses an internal credit rating from AAA to D to assess the borrower’s credibility, financial situation, management, and the perceived risk for the potential investor.
Does "senior secured" mean my capital is protected?
No, a senior creditor secured by the collateral does not mean that the capital is completely safe. Senior creditor status only improves the ranking in terms of priority of debt recovery in case of the collateral enforcement, but it does not guarantee that the investor would be completely or partially reimbursed, as the individual outcome would depend on the proceedings, the status of the claim, and the operational jurisdiction.
FAQ
What is senior debt?
Senior debt is a debt that has the highest priority of recovery and comes first, being backed by a particular collateral. The interest rate is typically lower because of the priority in the recovery process.
What is the difference between senior and subordinated debt?
Senior and subordinated debt creditors have different priorities during debt recovery. Senior creditors are the first in line when it comes to debt recovery. Subordinated debt holders are lower in the hierarchy but usually have a higher interest rate because of the higher risk of their position.
Is mezzanine debt secured?
Usually, mezzanine is either unsecured or comes in as the second charge in terms of recovery priorities. Mezzanine debt creditors therefore accept the trade-off by having a higher interest rate because of the higher risk of capital loss in case of the borrower’s financial incapacity to meet the debt obligation.
Who gets paid first when a borrower defaults?
If the borrower defaults, first of all, priority demands, like the demands of the workers of the business, are claimed. Then come senior creditors, then subordinate ones, then mezzanine, then equity, who have a completely unsecured position in the queue if the liquidation of the assets happens and the debt recovery procedure is on the run.
Does a secured loan guarantee I get my money back?
No, a secured loan does not guarantee that the investor will get their money back. Security and higher priority in the queue for debt recovery increase the chances of return but do not guarantee it.
About Maclear
Maclear AG is a Swiss peer-to-peer (P2P) lending and crowdlending platform, headquartered in Switzerland. The company acts as a financial intermediary in the non-banking sector and is a member of PolyReg SRO, in accordance with Swiss financial regulations, particularly regarding AML, KYC, and GDPR. Maclear provides individual and qualified investors access to carefully selected business loan opportunities, with integrated risk assessment, a Provision Fund, and a Secondary Market for liquidity.
The content of this article is provided for informational and educational purposes only. It does not constitute investment, financial, tax, or legal advice. Peer-to-peer (P2P) lending and crowdlending investments carry a risk of partial or total loss of capital. Past performance does not predict future results. Liquidity on a secondary market is not guaranteed. Readers are encouraged to conduct their own research and consult qualified advisors before making any financial decisions. The availability of products and services may be restricted in certain jurisdictions.