Financing for Subordinated Corporate Debt

The universe of subordinated debt includes high yield bonds, mezzanine financing both with and without warrants, payment in kind (PIK) notes, and vendor notes.

Given the flexibility of how subordinated debt can be structured and the varying levels of priority that accompany different kinds of subordinated debt, corporations are using subordinated debt more frequently in place of issuing preferred stock or other equity instruments to raise capital. As long as investor demand for subordinated debt continues, the corporate preference for subordinated debt will likely continue to grow.

Central State Financial LTD corporate debt finance specialists saw the growing demand for subordinated debt instruments long before the trend picked up steam. They developed critical expertise in evaluating corporate subordinated debt alternatives and advising clients on the benefits and risks of issuing subordinated debt over other financing alternatives. As the environment for corporate taxation has evolved and other corporate finance advisors shifted their focus to tax-advantaged financing transactions, our advisors structure subordinated corporate debt that includes tax deductible (and, therefore, tax-advantaged) interest payments. In certain situations, and most critically where debt is not convertible to equity, the corporate entity can pass those advantages through to shareholders.

Our corporate debt advisors frequently recommend subordinated debt facilities as a component of reclassification and conversion transactions. One possible structure, for example, would be an issuance of preferred stock that converts to debt when a corporation satisfies certain covenants and conditions, such as reaching achieving cash flow targets or paying down senior debt. We structure these transactions to give maximum control to corporate management over the timing and administration of conversion events.

As with every service that Central State Financial LTD provides for its clients, our advisors do not offer generic one-size-fits-all solutions when a client’s business plan and financing requirements call for a subordinated corporate debt facility. In every engagement, we begin by analyzing the client’s capitalization, business organization, growth model and historical performance,. We review economic and industry sector trends and look for potential market disruptions that can interfere with the client’s debt service for subordinated debt. Every recommendation accounts for and seeks to mitigate all major risk and applies structures that optimize tax efficiency.

Central State Financial LTD corporate debt finance team does not perceive subordinated debt as something more than just a way station between traditional commercial credit facilities and the issuance of corporate equity. Even where subordinated debt fulfills a mezzanine finance role, our advisors erect subordinated debt facilities that stand on their own benefits and that account for a client’s appetite for risk and its ability to manage financing in turbulent markets. The result is always a optimum financing solution the serves the client’s needs above all other considerations.
The Central State Financial LTD Approach to Subordinated Corporate Debt

A corporate entity that issues subordinated debt instruments inevitably faces a decision over how to balance the coupon or interest rate component of the debt against anticipated demand for the underlying debt instruments. Our subordinated corporate debt advisors utilize Central State Financial LTD proprietary research protocols and methodologies to prepare a profile of the corporate entity as a standalone entity and in comparison to its competitors. We also analyze current market, industry sector, and economic conditions and the likelihood of positive or adverse changes in those conditions to assess market acceptability of a subordinated debt issue.

Our advisors then move on to determine the best form of subordinated debt that will serve the client’s interests, including amortization terms (if any), maturity dates, and degrees of subordination in comparison to other debt carried by the corporation. A majority of our corporate debt structures include balloon repayments after two to seven years, but the final amortization and repayment terms are always a function of the client’s unique circumstances.

When the basic structure of the subordinated debt instrument is created, our advisors then turn to options that can enhance the instrument’s appeal, including warrants that give a holder the right to purchase new equity as a discounted strike price, and success fees or enhanced repayments that are triggered by defined events.  We give the client an option to cap overall returns or to leave them open, as market and industry conditions might require.

To the extent that a new issuance of corporate debt requires buy-in by board members or shareholders, our advisors will prepare detailed analytical models to the relative advantages and drawbacks of subordinated debt in relation to new equity issuances. We often see resistance to higher interest rates that are common to subordinated debt instruments, and we prepare for that resistance by offsetting leverage and other features that make subordinated debt more palatable to corporate interests. In every case, we verify that subordinated debt will not restrict the corporate entity from pursuing additional debt or equity financing and that management has free rein to operate the company without significant restrictions on use of capital.

From our experience and the historical perspective that we have attained over several years of advising clients on subordinated debt issuance, we perceive subordinated debt as being a better financing solution for companies that rely more on services rather than products to generate revenues. Consistent with this, we have advised wholesalers and distributors, logistics consultants, and supply chain service providers on the risks and benefits of using subordinated debt over collateralized debt financing. Our goal is always to enable our clients to improve shareholder returns with no erosion of cash flow or other financial performance indicators when a subordinated debt issuance is the source of financing.

With proper capital planning, a corporate entity can use subordinated debt to boost shareholder returns without risking cash flow that needs to be used for payments on senior debt.

A Special Case: Subordinated Corporate Debt to Finance Recapitalizations

Corporate entities often recapitalize to rebalance their debt-to-equity ratios and to stabilize their capital structures. Central State Financial LTD has formed a team of recapitalization specialists that use layers of subordinated corporate debt to accomplish recapitalizations for companies that are facing financial distress or that have devolved into crisis management. We have helped clients to avoid severe cutbacks and to stay out of receivership with new corporate debt that substitutes for more onerous financings.  

Central State Financial LTD uses its affiliations and relationships with international merchant and investment banks to locate lending resources that work with financially distressed clients to find long-term solutions and to help the entity to regain financial stability. Our specialists are adept at balancing current capital market conditions and the client’s own position in its industry sector. The result is an optimum solution that helps the client to recapture financial security while enabling corporate management to retain as much equity and control as a situation will allow. We do not present generic solutions, but focus on the client’s operating history, growth prospects in its industry, and specific capital requirements to create one-of-a-kind solutions that serve the client’s interests first.

Clients rely on our recapitalization knowledge and experience because of:

  • the extensive experience that our consultants have acquired through years of advising distressed companies on recapitalizations and restructurings
  • our in-depth knowledge of the laws and regulations that affect reorganizations in all major international jurisdictions
  • our experience in negotiating and amending credit facilities
  • our objective corporate valuations and fairness opinions
  • our expertise in interfacing with shareholder groups, vendors, and other stakeholders.
Our specialists consider every possibility in a restructuring engagement, including deleveraging, novel transactional structures that add excess cash to a corporation’s treasury and that increase book value, and intricately organized exit strategies. Our team provides expertise in short- and long-term growth strategies, adding value through mergers and acquisitions, moving debt off of balance sheets and into special purpose entities, and creating custom financial tools and debt offerings.
The Central State Financial LTD Approach to Using Subordinated Corporate Debt for Recapitalizations

Central State Financial LTD advisors begin recapitalization engagements with an in-depth analysis of a client’s existing debt or other financing facilities, the shareholders’ equity positions and the interests of those shareholders in retaining their positions, and the liquidity or cash-out options that shareholders will find most attractive.  We consider alternatives such as strategic acquisitions that can add upside potential without expanding downside risk, and use our international affiliations to source the funding for those acquisitions if they are the correct solution for a client.

Corporations have legitimate concerns over taking on the excess layers of debt and the reduction in immediately-available cash that accompany recapitalizations. To respond to these concerns, our advisors always develop at least two exit strategies that will retire debt upon the occurrence of defined conditions. We have developed recapitalization structures that conclude in IPOs, private sales, strategic partnerships, and transitions into new lines of business. We believe that the most successful and effective recapitalizations are those that continue the existence of the company, that build on its infrastructure and abilities, and that reduce cash flow burdens on management without imposing alternate stresses and demands on any operations.

While most companies will not consider a recapitalization until they are in serious financial distress, a smaller number of corporate entities will have the foresight to perceive pending distress and will begin the recapitalization process while they are in a stronger negotiating position. Our advisors have special expertise in formulating these strategic recapitalizations, for example, where a majority owner desires to sell an equity stake in a business while retaining some ownership and operating control, or where market conditions make present optimal conditions to exchange legacy financial structures with alternative financial mechanisms. Our ultimate goal in every recapitalization engagement is to reinvigorate the corporation with structures and systems that push its finances and operations to a higher level.

The Central State Financial LTD Approach to Leveraged Recapitalizations

Leveraged buyouts and recapitalizations have come under intense scrutiny as third-party private equity organizations have used them to draw funds out of established companies with no immediate or apparent economic benefits to stakeholders. Unlike those private equity entities, Central State Financial LTD approaches leveraged recapitalizations with consideration of all stakeholders, including shareholders, management, creditors, operating staff. We recommend leveraged recapitalization structures only when they are a preferred alternative to liquidations or other reorganizations that would have a greater adverse impact on all stakeholders.

Our advisors are sensitive to the near-term effect of a leveraged reorganization that substitutes debt for equity. Our recommendations never conclude with that end point. Rather, we develop realistic exit strategies that enable a corporation to rebuild a debt-to-equity ratio that is more in line with other companies in the applicable industry sectors. Funds that are realized through leveraged recapitalizations might be used to buy out existing shareholders and to transition the company from a public to a private entity. With a well-structured leveraged recapitalization, this is a temporary solution and a viable alternative when a company is otherwise unable to increase the price of its shares through other substantive means. The longer-term solution that we present will frequently include options to re-enter the public markets.

Our leveraged recapitalization team members do not provide services that are divorced from the greater markets or other economic circumstances. We strive to be a good corporate citizen that focuses on more than the next quarter’s financial results. We have adopted this as a guiding principle for all advice and consultation that we offer in structuring recapitalizations that will deliver the greatest benefit for all stakeholders while simultaneously providing a positive impact on the company’s greater community.

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