Everything You Need to Know About Senior Equity
Corporations and governments consider issuing various financial securities when they need funds like debentures, Bonds, preference shares,equity shares,and more, via the general public. Against those funds, these financial securities offer returns as dividends and interest. In the worst scenario, a company announces liquidation. In such an instance, the company repays the funds to senior security first.
This article focus on senior security meaning, ranking of senior security, and examples of it.
What is Senior Security?
Senior security is the one that gets the top priority when it comes to repayment, in the instance of a company’s financial trouble. Senior securities are ranked in the order of priority status for repayment. The highest-ranked are paid out first and the lowest-ranked are the last to receive payment. Since the top-ranked securities offer higher safety, the return on investment offered is lower. However, the lowest-ranked securities are highly risky, as their repayment is in doubt when the issuer default. Therefore, they offer high returns to investors.
Senior security for a company depends on its capital structure which differs from each other. If the company issue equity shares, debt, and preferred shares, debt securities are the top-ranked senior security followed by preferred and equity stock. If the company only issues preference shares and equity shares, preference shareholders get the benefit of seniority.
In the debt securities, the senior debt securities are ranked above the junior debt securities. The contract or indenture agreement between the company and bondholders necessitates the company to keep up the seniority status. If the company comes with any further issue of the new debt securities, it will be treated as junior to the claim by existing bondholders. In the instance of liquidation, equity stockholders, usually, get repaid last and only if the company has funds left after paying debt security holders and preferred stockholders.
The company ABC Ltd. had issued secured bonds, preference shares, and equity shares. The company came with an additional issue of debt after two years. Recently, the company announced liquidation. Here is the sequence of senior security rankings.
- Secured bondholders will get repaid first.
- The bonds junior to secured bonds will be repaid afterwards.
- Then, preferred stockholders will get the repayment.
- Equity holders will get repaid at last if the company still has funds.
What is the ranking of Senior Security?
- Secured bonds or mortgage bonds get the top ranking for the repayment of principal. As collateral assets back the secured bonds, they offer lower returns.
- After a secured bond, senior bondholders have the right to claim repayment in case of financial troubles of the company.
- Junior bonds are ranked after secured and senior bonds. They offer a bit higher return as compared to both top-ranked bonds.
- After junior bonds, the next preference is given to insured or guaranteed bonds. These are the bonds for which a third party agrees to take up the responsibility of repayment if the issuer defaults.
- The next rank is given to convertible bonds, which gives the bondholder the right to convert the bond to equity after some time. Though, if the issuer default, this option does not work. These bonds are paid out after all the above bonds, but before preference and equity holders.
- The preference shareholders hold the next rank after all the debt securities are paid. Though, they are preferred over equity shareholders for repayment.
- Equity shares, which have a high potential for returns, are ranked the lowest in terms of safety and seniority of repayment. Common stockholders only get paid if the company is left with any fund after paying all the debtholders and preferred stockholders.
Examples of Senior Securities
Secured Debt: Secured debt is considered senior security to unsecured debt. Secured debt refers to any security where the issuer put up an asset or any item of value as collateral for the lender. If the issuer fails to repay, the title of the collateralized asset would be transferred to lenders for covering their losses. This includes secured bonds such as Collateralised Debt Obligation, Mortgage-backed securities, etc.
Guaranteed bond: Guaranteed bonds are treated as senior securities. These are the bonds for which a guarantor guarantees the repayment if the issuer announces insolvency. A guarantor can be a bank, insurance company, or any subsidiary, and so on. They offer safety to investors as they are guaranteed by a third party in addition to the issuer.
Preference shares: Preference shares are the senior securities to common stock. Though preference shareholders do not have a right to vote, they are entitled to receive payment before equity shareholders. Preference shares offer a higher return as compared to debt securities, though lower than equity.
To wrap up, senior security is the security with a higher preference for repayment when an issuer company is dissolved. Highest ranked securities offer more safety and lower returns and the hierarchy goes on. The lowest-ranked securities are highly risky and thus, provide investors with high potential returns. The seniority ranking depends on the capital structure of the company.
Frequently Asked Questions Expand All
You can invest in senior securities by purchasing preferred stock instead of equity. Preference shareholders are paid out dividends and are preferred over common stockholders in the case of bankruptcy. Bondholders get repaid even before the preference shareholders. You can also invest in senior debt security which enjoys preference over junior debtholders, preference shareholders, and common stockholders.
Senior security gets top ranking when it comes to repayment. This type of security is believed to be safe and thus offers a lower return to investors, compared to lower-ranked securities.