Corporate entities are increasingly switching from preferred equity to subordinated debt to finance sales and other transactions.  Subordinated debt is perceived as providing better assurances of payments regardless of whether corporate earnings are positive or negative. Moreover, certain subordinated debt notes will have higher valuations than preferred stock in resale transactions, and even subordinated debt will take precedence over holders of corporate equity if a corporation needs to be liquidated due to insolvency. 

Banc Star Financial’s subordinated debt advisors focus on these and other considerations in advising clients on the benefits and risks of subordinated debt. Where, for example, a corporation would benefit from a tax-advantaged financing transaction, our advisors will focus on corporate debt, which (unlike preferred stock dividends) provides interest payments that are tax deductible. In the current tax environment, if a company maintains S-corporation status, it can take advantage of pass-throughs if the subordinated debt does not have reclassification provisions that envision conversion of debt to equity.

Banc Star Financial’s subordinated debt advisors take a unique approach to reclassification and conversion features. When S-corporation status is a secondary concern, we might structure a subordinated debt transaction with preferred stock that converts to debt upon occurrence of certain conditions, such as achieving cash flow targets, pay-down of debt to senior lender, or meeting other defined financial ratios.

Other investment or merchant banks might fall back on standard structures for subordinated debt transactions, with a corresponding attempt to fit the transaction into a pre-defined financing facility. Banc Star Financial rejects a one-size-fits-all approach. We begin every subordinated debt financing engagement with an in-depth analysis of the client’s capitalization and stock, its future earnings potential, its presence in its industry and in applicable markets, and its needs for risk mitigation and tax advantages.

In many cases, subordinated debt assumes a status between traditional commercial bank debt or lines of credit and a company’s equity structures. This middle stance has given rise to a mezzanine financing specialty among many investment and merchant banks. Rather than forming internal teams of advisors and consultants around semantic labels, Banc Star Financial’s specialists develop unique subordinated debt solutions that factor in the higher risk levels of that debt with optimum financing terms and conditions that meet the client’s needs first.

Banc Star Financial’s Subordinated Debt Philosophy

Our subordinated debt team reaches the ideal current return or “coupon” component of that debt by combining the interest  rates that a buyer will agree to pay with the lender’s demand for a full expected return.  In the current international economic environment, our advisors negotiate current returns in a range from 12-14%. Some transactions will include Paid in Kind (PIK) interest that accrues to principal for deferred payment. Unlike senior corporate debt, subordinated debt payments are generally not amortized but are paid in full at maturity, which can be as short as two years or less or as long as five to seven years.

Subordinated debt structures are often combined with warrants that give a lender an option to procure equity as a discounted strike price. If the lender does not exercise those warrants, the buyer might then repurchase them at an appreciated value. Banc Star Financial has also been a pioneering industry participant in the use of success fees that give lenders additional fixed payments with caps on returns.

We simplify corporate debt decisions by preparing our analyses to show the relative costs of subordinated debt in comparison to equity. Although subordinated debt interest rates are high, the returns of that debt are typically lower than equity, which can demand returns that are up to twice as high as subordinated debt. Subordinated debt lenders are often willing to accept greater leverage. Even though a highly leveraged transaction will impose a larger interest burden on the borrower, subordinated debt is more readily structured with interest-only payments and a balloon principal payment at the end of a defined term.

Banc Star Financial specifically perceives subordinated debt to be an ideal financing alternative for companies that emphasize a services-based earnings environment (e.g. distributors, logistics companies, etc.) over collateral that can be used to secure debt financing. In every situation, our subordinated debt advisory team works with our clients to weigh the risks and advantages of subordinated debt within the client’s capital structure in view of expected outcomes and returns available in any transaction. 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.

Banc Star Financial‘s recapitalization team develops tailored solutions for  corporations that have fallen into financial distress. Our team members have experience in bringing clients out of  pre-crisis situations, creating out-of-court workouts, and advising on court-supervised reorganizations.

We leverage our relationships and status in the international merchant and investment bank community to develop optimum solutions for our clients in view of current capital market conditions and of the client’s own position in its industry. Our approach provides the most comprehensive and effective solutions for debt recapitalizations that may be available in the domestic and international arena. Our specific recapitalization services encompass:

  • multiple years of expertise in recapitalization and restructuring;
  • domestic reorganizations under Chapter 11 and international reorganization under the laws of each applicable jurisdiction;
  • amendments of credit facilities;
  • debt exchange offers;
  • corporate valuations and fairness opinions;
  • negotiations with shareholder groups and other stakeholders;
Our team adopts a goal in every recapitalization engagement of assisting a client to achieve financial security while retaining as much equity and control over corporate management as a situation will allow. Every recapitalization engagement offers a potential for deleveraging, adding value with transactions that exceed their cash or book value, increasing value with planned and managed exit strategies. Team members participate in every component of a recapitalization transaction, including providing strategic oversight, knowledge and experience in mergers and acquisitions, and maximizing value with custom tools and debt offerings. 
Advantages and Drawbacks of Recapitalizations

Most companies that are considering recapitalizations of existing debt or other financing facilities will start that process with a goal of retaining the shareholders’ equity positions and providing shareholders with material liquidity options. Even with a pending recapitalization on the horizon, our services can help a company to locate outside equity capital to fund strategic acquisitions that enhance upside potential with a minimum of downside risk.

We formulate two or more exit strategies in our recapitalization recommendations, often including options for an initial public offering (IPO) and a private sale. A successful recapitalization will typically increase a corporation’s debt load and reduce its immediate cash-on-hand. Our industry status and international reputation give us access to multiple partners that can participate in a recapitalization without imposing onerous burdens on existing management.

A company can benefit from a recapitalization even if it is not in financial distress. Consider. For example, a corporate owner that seeks to sell an equity stake in a business while retaining some ownership and operating control. A well-structured recapitalization can generate capital that enables the owner to sell either a majority or minority stake to a select partner without ceding control and while maintaining a significant equity stake. The best recapitalizations bring a trusted advisor onto the company’s board to help the company take its business and operations to another level. 

Leveraged Recapitalizations
A substantial number of recapitalizations effect critical changes to a company’s capital structure by replacing equity with debt.  The funds that are realized through these structures are often used to buy out shareholders, particularly when a company seeks to exit the public equity markets. Debt securities that are issued for this purpose may be a preferred alternative when a company is unable to increase the price of its shares through other substantive means.
The political class has criticized certain leveraged buyout transactions that are initiated by third parties to the extent that these transactions load a corporation’s balance sheet with debt and leave the corporation with a significantly higher debt-to-equity ratio.  Banc Star Financial is sensitive to these criticisms, and balances the benefits of recapitalizing debt against the drawbacks of the effects on a company’s balance sheet. In many situations, a leveraged recapitalization is the preferred alternative to falling stock prices, hostile takeovers, bankruptcy reorganizations, and other transactions that impose a greater burden on the company and its operations. Our team members take great pride in structuring recapitalizations to achieve the greatest benefit for shareholders and management while minimizing the impact on the company’s immediate community.