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Senior debt is the highest-priority borrowing in a company's capital structure. It gets repaid first in a liquidation or bankruptcy, ahead of subordinated debt and equity. Lenders who extend senior debt typically require collateral or strong financial covenants in exchange for that priority, and they accept lower interest rates because their risk is lower than other creditors.
Think of it like the first mortgage on a house: if the owner defaults, the first mortgage holder gets paid before anyone else with a claim on that property.
Every company that borrows money has a capital stack, which is the hierarchy of financing sources ordered by repayment priority. Senior debt occupies the top. Below it sit subordinated debt instruments like mezzanine financing and high-yield bonds. Equity holders are at the bottom and absorb losses first.
The position in the stack determines both the interest rate and the risk profile. Senior lenders charge the least because they get paid before anyone else. Mezzanine lenders charge more because they wait. Equity investors demand the highest returns because they absorb all the losses before anyone above them feels pain.
Senior debt can be either secured or unsecured. Most leveraged buyout financing and commercial bank lending uses secured senior debt, backed by the company's assets through a first lien. This gives lenders a direct legal claim on specific collateral if the borrower defaults.
Some senior debt is unsecured, meaning it carries no collateral backing. Investment-grade companies often issue unsecured senior notes because their credit quality and cash flow reliability reduce lender risk to an acceptable level without pledging assets.
Senior debt takes two main forms in practice. The first is bank loans, also called leveraged loans or term loans, which are provided by commercial banks and institutional investors and typically carry floating interest rates tied to benchmarks like the Secured Overnight Financing Rate. The second form is senior secured bonds, which are publicly issued, carry fixed interest rates, and trade in secondary markets.
Both sit at the same priority level in the capital structure, but they differ in flexibility and tradability. Bank loans are private instruments with negotiated terms. Bonds are standardized, rated by credit agencies, and bought and sold by a broader set of investors.
Senior lenders typically impose covenants in their loan agreements to maintain leverage below a certain threshold, maintain minimum interest coverage ratios, and restrict the company from selling key assets or taking on additional debt without approval. These covenants give lenders early warning and intervention rights if a borrower's financial condition deteriorates.
Covenant-lite loans, which became common in the leveraged buyout market between 2020 and 2022, strip out most maintenance covenants. They carry higher risk for lenders even though they remain technically senior in the capital structure.
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