Senior Term Debt is the second most common financing for a mid-sized company. Senior Term Debt is typically lent against the collateral value of property, plant and equipment. Senior Term Debt comes in many varieties and there are many sources of this type of financing. It is typically the second most expensive form of financing.

Typically 50% to 70% of a firm's capital structure is comprised of senior debt. A senior loan is collateralized by a first lien on the current and long term assets of the company. Senior financing is generally made available from banks and finance companies, although privately-placed notes to institutional investors are also possible, or a public issue of bonds is occasionly the source.

Loan Principal

The amount of Senior Term Debt typically provided to a company depends on the type and quality of its collateral and the stability of its cash flow. A senior lender's first priority is to analyze the value of the assets. Generally the Company's current assets are already "claimed" by a Revolving Line of Credit, therefore, term loans are collateralized by the value of the Company's fixed assets. The term loan will be based on a formula that applies an "advance rate" to the assets in order to determine their current market value, and accordingly, the amount that may be borrowed using the assets as collateral. While the advance rates depend on the type, age and quality of the assets, typical advance rates are 60-85% of the appraised fair market value of the land and buildings and 40% to 90% of the orderly liquidation value of the machinery and equipment.

The amount of term debt advanced is further limited by the predictability of the company's cash flow to service senior debt. If the company has stable cash flows, the lender may provide additional funds above the collateral coverage. Cash flow lenders consider earnings before interest, taxes, depreciation and amortization ("EBITDA") as a proxy for the Company's cash flow and may lend up to a certain multiple of EBITDA. This multiple will vary greatly between industries and is very dependent on the Company's health and competitive position. For purposes of performing a preliminary analysis, 3x EBITDA is a median EBITDA multiple for a senior lender.

Loan Term and Debt Amortization

Senior Term Debt typically amortizes over 4 to 7 years. These payments are generally monthly or quarterly. However, the amortization schedule can be more erratic and may be structured to conform to the company's projected cash flows. For example, amortization payments may gradually increase over time in consideration of a company's expected growth. Some lenders are willing to forego amortization payments for a number of years and allow the loan to be repaid in one or a few large payments. Typically, the longer the time to repayment, the higher the interest rate will be.

Sometimes lenders will impose a prepayment penalty on any amount of the loan that is repaid ahead of the scheduled amortization. These penalties are often a percentage of the amount prepaid.

Interest Rate

Interest rates on Senior Debt range from one-quarter percent under prime to five percent over prime, depending on the perceived risk of the company's cash flow and the quality and quantity of collateral. Interest rates may be fixed or floating. Sometimes a lender will tie the interest rate to a schedule, such that if the company becomes less leveraged, the interest rate decreases because the company's risk has also decreased.

Security

Senior debt has priority claims over subordinated debt with respect to collateral value and cash flows. The senior lender applies advance rates to ensure that the loan amount is less than the quick-sale value of the assets. In order to maintain this level of security, most lenders require monthly or quarterly asset audits to ensure the value of the collateral is not decreasing.

Financial Covenants

Loans that have a large cash flow component will often require financial covenants to keep the company within certain financial parameters. For example, the lender may want the company to stay below a certain ratio of debt to cash flow and to stay above a certain ratio of cash flow to interest. Breaking a covenant may put the Company in default. However, it is important to keep in mind that the lender uses covenants to exert some control over the business in order to protect the loan.