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Subordinated loan

The name 'subordinated loan' has a negative connotation for many people. It sounds as if 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 it 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 if you are looking for money for your company, you can take out a business credit or take out a business loan . By taking out this loan, you must repay a certain part, plus interest, of this loan every agreed term. Nevertheless, there are often strict conditions attached to this, which not every entrepreneur can meet. Hence, there are other ways to get money. Examples are crowdfunding and factoring , but a subordinated loan is also one of the options.

A subordinated loan is a loan where the provider of the Credit, the one who issues the loan, is subordinated to most other creditors in the event of bankruptcy of the company. This means that this creditor only has to be paid as one of the last and therefore will most likely see little or nothing in return from the loan provided. Only the holders of a bond or a share are still behind the provider of this loan.

Another form is the Mezzanine loan. This loan is in fact the same as a subordinated loan and also has the same risks. The difference is that with a Mezzanine loan a middle way 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 as an entrepreneur to get money from the bank. An alternative to this 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 charge 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 get (part of) the invested money back in the event of bankruptcy.

Venture Capital (Aunt Agaath)

Nevertheless, a subordinated loan does not always have to be large amounts. It may also be that you want to start your own business or take over an existing business and need a relatively small amount to do so. In that case it is possible to apply for 'venture capital'. This is also called the Aunt Agaath scheme. This scheme is based on the money of family, friends or acquaintances who want to help you set up your own business. When they decide to lend you money, they reap some benefits. For example, these persons can receive an exemption from the yield tax. To be eligible for this, a number of rules must be met. For example, the amount borrowed must be at least USD 2,269. In addition, this money must be borrowed before the company is set up and the interest that is settled may not be higher than described in the law. The conclusion of the loan must also be recorded on paper. This contract must be registered with the tax authorities.

Venture capital risks

As the name 'venture capital' suggests, the provider of an Aunt Agaath loan requires quite a bit of guts and courage. In some cases, the risks are very high. And not only the risks of an Aunt Agaath loan are an important factor. There are many more things to consider, for example the industry in which your company operates, the financial prospects and the situation in which your company finds itself. These lenders invest in your business out of confidence. This can ensure that you are even more careful with the money, because you prefer to pay everything back, but unfortunately this does not offer any security.

Venture capital is also a subordinated loan. Although the name is different and it often involves relatively smaller amounts, there is no difference between these two types of loans. This means that in the event of an unexpected bankruptcy, these investors too will only have the last 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 invested money may never be paid back.

Example 1

Your business is not doing well and you are in dire straits. You therefore need an amount of USD 5,000 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 is willing to help you; they put some money together and give you this USD 5,000 as a loan. You pay substantial interest on this for each agreed term, but this loan makes things a little better again. A win-win situation for you and your family. If things do go wrong in the end and you run into bankruptcy, the family will most likely not see the USD 5,000 again.

Example 2

You have your eye on a small business that you would like to acquire. You need USD 10,000 for this, but the bank does not want to give you a loan. A vague acquaintance owns a similar company and sees opportunities to do business with you in the future. That's why he lends you USD 10,000 as a subordinated loan. You pay a substantial interest on this to your acquaintance, but if the takeover 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 bring in enough money. Especially when it comes to a company in need, which 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 of your companies that you sell to investors. They pay for this, but the recipient receives a reward in exchange for this investment. This compensation can consist of interest, variable or fixed. In most cases, bonds have a fixed term, so that you as an entrepreneur can be sure that they have access to the loaned money for the entire period. In some ways it looks like a stock, 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 repaid all other loans and bonds. However, this does not mean that the holders of subordinated bonds are the last to act 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 the money, are an acquaintance. Still, all forms of subordinated loans come with advantages for the investor, and therefore also the Aunt Agaath loan.

In box three, for example. The lender may deduct his or her investment from the assets in box three for the first eight years after granting a loan. The maximum amount of this exemption is USD 54,223, while most subordinated loans are likely to be less than this amount.

Due to the exemption that the lender also receives, the capital yield tax to be paid is lower. However, someone will only benefit from this if the existing capital exceeds the threshold for box three. This threshold is currently USD 21,139. If the lender has less than USD 21,139 in capital, this tax benefit does not apply when granting a subordinated loan.
Although there are relatively many risks attached to a subordinated loan, these risks can already be reduced during the term. If you, as a debtor, are unable to meet your payment obligations, chances are that the lender can definitively whistle for the invested money. To prevent this, to a certain extent, it is possible in that case to cancel the subordinated loan and enter it as a personal deduction. However, this must be done within eight years of taking out the loan. The tax authorities also require a decision stating that you, the recipient, are no longer able to repay the claim.

Advantages with an acquisition

In many cases, a subordinated loan is not financed according to the Tante Agaath scheme, simply because the amounts are too large for this. It could also be that the lender is a party that wants to sell a company. In the most favorable cases, a win-win situation can arise with a subordinated loan in the event of a business acquisition.

You may want to sell your business. There are several possible reasons for this. Finding a good takeover candidate is then an important task. When you have found this person, it is always the question whether they also have the money to actually realize the takeover. If this is not the case, a subordinated loan can be a good alternative.

An advantage of this is that if you require the acquisition candidate to reach out to their full assets, you may not get the price for your business that you had in mind. By offering the buyer a subordinated loan, you usually receive more money for the business.

A subordinated loan in a business acquisition can therefore lead to a win-win situation for both the buyer and the seller: the seller receives a larger amount for the company, while the buyer has to invest less of the equity capital. Yet this construction only has a chance of success if both parties know well with whom they are going to work.

Security for other creditors

There is a high interest rate against a subordinated loan. 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 without collateral, such as working capital or expansion plans. Yet it can also bring benefits for the entrepreneur. If you want to make a high and complex financing request, having a subordinated loan may be the deciding factor.

This is called a stack financing. An example of this is the Mezzanine 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 are more likely to do business when you have a subordinated loan. Why? That is quite simple: if your company still goes bankrupt, it is not the bank or the financial institution, but the provider of the subordinated loan that will take the first blow.

What are the risks?

When you receive a subordinated loan, you can carry out the business you intended to do. Because there are also advantages to a subordinated loan for the lender, it may seem interesting for both parties. Yet there are indeed major risks involved. The greatest risks are not for you as an entrepreneur, but for the investor.

Subordinated loans are, in some cases, made by ailing companies. For this, such a loan is the last resort. The money that comes in as a result is then used to bridge a difficult period and perhaps even to prevent an impending bankruptcy. At that time, the investor can demand a high interest rate and thus earn a lot of money in a short time, but then the company has to survive this difficult time.

If this is not successful and the company goes bankrupt, a receiver will be appointed after the bankruptcy has been declared. The chance that the provider of a subordinated loan will then still be discussed is almost nil. As mentioned earlier, in a bankruptcy, the 'normal' creditors such as the tax authorities, banks, suppliers and other creditors are discussed first. Only then is it the turn of the provider of the subordinated loan, and then there is a good chance that the money is no longer there.


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