Senior Secured Debt
Revolvers, term loans, syndication, and the mechanics of first-lien lending
~20 min read
In a leveraged buyout, debt is the engine that amplifies equity returns. A PE fund might contribute 40% of the purchase price in equity and borrow the remaining 60% from banks and institutional lenders. That borrowed 60% is not a single loan. It is a carefully structured stack of different debt instruments, each with its own priority, pricing, and repayment terms. At the top of that stack sits senior secured debt, the safest and cheapest layer of the capital structure.
Senior secured debt is 'senior' because it gets paid first in any scenario, whether that is routine interest payments or a liquidation. It is 'secured' because it is backed by collateral: the borrower's assets, cash flows, or both. If the company defaults, the senior secured lenders have a legal claim on those assets ahead of everyone else. This combination of priority and collateral is what makes senior debt the lowest-risk, lowest-cost layer of an LBO's capital structure.
The Capital Structure Stack
Think of a company's capital structure as a waterfall. Cash flows and asset claims flow from the top down. Senior secured lenders sit at the very top: they get paid first during normal operations and have first claim on collateral in a default. Below them sit subordinated and mezzanine lenders, then preferred equity, and finally common equity holders (the PE fund). The lower you sit in the stack, the higher your risk and the higher the return you demand as compensation. This priority ordering is called the seniority of the claim, and it is the single most important concept in credit analysis.
Senior secured debt comes in two primary forms: revolving credit facilities (revolvers) and term loans. They serve fundamentally different purposes in an LBO.
A revolver works like a corporate credit card. The company has access to a committed line of credit (say, $100M) that it can draw on, repay, and draw on again as needed. Revolvers are used primarily for working capital management: funding seasonal inventory builds, bridging timing gaps between paying suppliers and collecting from customers, or handling unexpected short-term cash needs. In most LBOs, the revolver is sized at $50M-$200M depending on the company's working capital cycle. It is typically undrawn at closing and serves as a liquidity cushion. The company pays a small commitment fee (typically 0.25-0.50% annually) on the undrawn portion.
A term loan is a lump sum borrowed at closing that must be repaid over a defined schedule. Term loans are the workhorse of LBO financing. They provide the bulk of the debt capital used to fund the acquisition. Unlike a revolver, a term loan cannot be re-borrowed once repaid. There are two main varieties:
- Term Loan A (TLA) is amortizing: the borrower makes regular principal payments (typically 5-10% of the original balance per year) plus a balloon payment at maturity. TLAs are held by banks.
- Term Loan B (TLB) has minimal amortization (typically 1% per year) with nearly all principal due at maturity (a 'bullet' payment). TLBs are sold to institutional investors like CLOs and credit funds and are the dominant form of term loan in leveraged finance today.
| Revolver | Term Loan A | Term Loan B | |
|---|---|---|---|
| Purpose | Working capital, liquidity buffer | Acquisition financing | Acquisition financing |
| Borrowing | Draw and repay as needed | Lump sum at close, no re-borrowing | Lump sum at close, no re-borrowing |
| Amortization | None (revolving) | 5-10% per year | ~1% per year (bullet at maturity) |
| Typical maturity | 5 years | 5-6 years | 6-7 years |
| Held by | Banks | Banks | Institutional investors (CLOs, credit funds) |
| Pricing (SOFR +) | 200-300 bps | 225-350 bps | 300-500 bps |
First Lien vs. Second Lien
Both revolvers and term loans are secured by liens on the borrower's assets. A first lien gives the lender the primary claim on collateral. In a default, first-lien lenders are paid first from the sale of the pledged assets. A second lien gives the lender a subordinate claim: they only receive proceeds after first-lien lenders are made whole. Because second-lien lenders bear more risk, they charge a higher interest rate, typically 200-400 basis points above first-lien pricing. Second-lien term loans became popular in the mid-2000s as a way to add leverage without bringing in a structurally subordinated mezzanine lender. In a typical LBO, the first-lien debt (revolver + term loan) might represent 3.0-4.0x EBITDA, while a second-lien tranche adds another 0.5-1.5x.
Syndication: How Large Loans Get Distributed
Most LBO loans are too large for any single bank to hold on its balance sheet. A $500M term loan B, for example, would represent excessive concentration risk for one lender. The solution is syndication: one or two banks (the 'arrangers' or 'lead left' banks) underwrite the full loan, then sell pieces to a syndicate of 20-50+ institutional investors. The arranging bank earns an upfront fee (typically 1-3% of the loan amount) for structuring and distributing the deal.
In a club deal, a small group of 3-5 banks jointly underwrite and hold the loan rather than broadly syndicating it. Club deals are more common in the middle market ($200M-$500M total debt) where the loan is small enough that a few banks can absorb it. Club deals offer borrowers faster execution and simpler lender negotiations, but the lending group has more concentrated influence.
SOFR + Spread Pricing
Leveraged loans are floating-rate instruments, meaning their interest rate resets periodically. The rate is expressed as SOFR (Secured Overnight Financing Rate) plus a fixed spread. SOFR replaced LIBOR as the benchmark reference rate in 2023. If SOFR is 4.50% and the spread is 350 basis points (3.50%), the all-in interest rate is 8.00%. Most leveraged loans include a SOFR floor (typically 0.50-1.00%) that sets a minimum for the reference rate, protecting the lender in low-rate environments.
The spread is determined by the borrower's credit quality, measured by leverage (total debt to EBITDA), the amount of equity cushion below the debt, and the overall market environment. In a borrower-friendly market, first-lien term loan B spreads might be SOFR + 300-350 bps. In a tighter market, spreads can widen to SOFR + 450-550 bps or more.
Life of a Syndicated Leveraged Loan
Mandate
The PE sponsor selects an arranging bank (or co-arrangers) to structure and underwrite the financing package for the LBO.
Commitment letter
The arranging bank issues a commitment letter guaranteeing it will provide the full loan amount. This gives the PE sponsor certainty of financing before the acquisition closes.
Syndication
The arranger markets the loan to institutional investors (CLOs, credit funds, insurance companies) through a roadshow. Investor appetite determines final pricing and terms.
Allocation & closing
The arranger allocates pieces of the loan to syndicate members. The loan closes simultaneously with the acquisition, funding the purchase.
Secondary trading
After closing, syndicate members can buy and sell their loan positions in the secondary market. Leveraged loan trading volume exceeds $800 billion annually.
Mandate
The PE sponsor selects an arranging bank (or co-arrangers) to structure and underwrite the financing package for the LBO.
Commitment letter
The arranging bank issues a commitment letter guaranteeing it will provide the full loan amount. This gives the PE sponsor certainty of financing before the acquisition closes.
Syndication
The arranger markets the loan to institutional investors (CLOs, credit funds, insurance companies) through a roadshow. Investor appetite determines final pricing and terms.
Allocation & closing
The arranger allocates pieces of the loan to syndicate members. The loan closes simultaneously with the acquisition, funding the purchase.
Secondary trading
After closing, syndicate members can buy and sell their loan positions in the secondary market. Leveraged loan trading volume exceeds $800 billion annually.
Quiz: Senior Secured Debt
6 questions · ~3 min