A first-out/last-out unitranche is one loan that the lenders divide between themselves. The borrower signs one credit agreement, grants one lien and pays one blended rate. Separately, the lenders sign an agreement among lenders that puts a first-out piece, often held by a bank, ahead in repayment for a lower return, and a last-out piece, usually held by a credit fund, behind it for a higher one. It lets a bank and a fund finance a deal together without two loans and an intercreditor agreement. The split rarely matters until the company is in trouble; then it decides who controls the outcome.
- What the borrower signs
- One credit agreement, one lien, one blended rate
- What the lenders sign
- An agreement among lenders that splits payments and control
- First-out
- Repaid first, priced lower; often a bank or the revolver provider
- Last-out
- Repaid after the first-out, priced higher; usually a private credit fund
- When the split bites
- Payment defaults, acceleration, enforcement and a sale in distress
How the split works
A unitranche loan replaces a senior loan and a subordinated loan with one facility at one rate. Many unitranche loans are held by a single lender, or by a group of lenders who share equally. In a first-out/last-out structure, often shortened to FOLO, the lenders go one step further: they carve the same loan into two economic pieces and agree, among themselves, who is paid first and who earns more.
The borrower does not see two loans. It draws one balance, pays interest at one rate to one agent and reports to one set of covenants. The agent collects every payment and then divides it according to the agreement among lenders, often called the AAL. In the ordinary course, interest is split so that the first-out holder receives a lower return and the last-out holder a higher one. Scheduled principal may be shared or may go to the first-out first, depending on what the lenders agreed.
A worked example in plain numbers. A company borrows 10,000 in one unitranche loan and pays 900 of interest a year. Behind the scenes, a bank holds 6,000 as the first-out piece and a credit fund holds 4,000 as the last-out piece. The agreement among lenders gives the bank 420 of the interest and the fund 480. The bank earns less on each dollar it lent because it will be repaid first if the business fails; the fund earns considerably more on each dollar because it will be repaid only after the bank. The borrower pays 900 either way.
The borrower's rate is set in the credit agreement. How the lenders divide it is their contract, not the borrower's.
Why lenders build it this way
FOLO exists because banks and credit funds want different things from the same company. A bank wants a safe position priced at bank returns, and it often wants the rest of the relationship: the operating accounts, treasury services and the revolving line. A credit fund wants a higher return and will take more risk to get it. Neither alone may want to hold the whole loan at the blended rate. Together, each gets the risk and return it is built for, and the borrower gets one loan that goes further than the bank would go alone.
Senior cash-flow lenders to lower-middle-market companies commonly lend 2x to 3.5x EBITDA; unitranche lenders stretch further. A FOLO lets the bank sit inside the range it is comfortable with while the fund takes the slice above it. The traditional way to get the same result is a senior loan plus a second lien loan or mezzanine debt, which means two credit agreements, two sets of covenants and an intercreditor agreement the borrower must negotiate and sign. FOLO moves that negotiation to the lenders' side of the table.
A common variant makes the revolving line the first-out piece. The revolver lender, often a bank, is repaid ahead of the term loan held by the fund, which is why the revolver is priced lower. Borrowers who rely on a working capital line should know whether their revolver sits this way, because it decides who is paid first from receivables and inventory in a bad year. The split-lien structure between an asset-based line and a term loan does a similar job with two loans instead of one.
FOLO next to the structures it replaces
| Question | Unitranche, one holder | First-out/last-out unitranche | Senior plus second lien or mezzanine |
|---|---|---|---|
| Credit agreements the borrower signs | One | One | Two |
| Who the borrower deals with day to day | One lender | One agent, speaking for both pieces | Two lenders |
| Rate the borrower pays | One blended rate | One blended rate, divided by the lenders | A lower rate on the senior loan and a higher one on the junior loan |
| Contract setting priority between lenders | None needed | Agreement among lenders, which the borrower often does not sign | Intercreditor agreement, which the borrower usually signs or acknowledges |
| Who must agree to a covenant reset | The one lender | Required lenders as defined; certain changes need both pieces | Each lender under its own documents, within intercreditor limits |
| What changes after a default | Nothing between lenders | The payment waterfall switches: first-out is paid in full before last-out | Payment blockage and standstill under the intercreditor |
The borrower gains simplicity and usually a lower blended rate than a plain unitranche from a fund alone, because part of the loan is priced at bank returns. It gives up some visibility: the terms that govern the lenders' relationship sit in a document the borrower may never sign. Whether that trade is worth it depends on how likely the company is to need an amendment during the life of the loan.
Two shapes: silent split and visible tranches
FOLO comes in two forms, and it matters which one a term sheet describes.
- The split lives only in the agreement among lenders. The credit agreement shows one loan at one rate. Prepaying part of the loan reduces the balance at that rate, and the borrower does not care which lender is repaid. This is the form most people mean by FOLO.
- The split is written into the credit agreement as two tranches. The borrower sees a first-out term loan and a last-out term loan with different rates and sometimes different maturities. Now the order of repayment changes the borrower's cost: repaying the cheap first-out tranche first leaves the expensive last-out tranche outstanding, and the blended rate rises as the loan amortizes.
In the second form, ask the lenders to model the blended rate year by year under the scheduled amortization, and read how voluntary prepayments and excess cash flow sweeps are applied. It is also worth asking how any prepayment premium is calculated and which piece it applies to. Last-out holders often insist on call protection that the first-out holder would waive.
What happens in a workout
While the company performs, a FOLO behaves like any other unitranche. The split comes into force when something goes wrong. The agreement among lenders names trigger events, typically a payment default, a bankruptcy filing, acceleration of the loan and sometimes a financial covenant default. After a trigger, the waterfall switches: every dollar collected goes to the first-out holder until it is repaid in full, and only then to the last-out holder.
Control shifts too. The agreement among lenders usually gives the first-out holder the right to direct enforcement for a period after a default, while the last-out holder stands still. After that period, control may pass to the last-out holder if the first-out has not acted. The last-out holder commonly has the right to buy out the first-out piece at par, which gives it full control of the loan. A fund that believes in the business may use that right to take charge of the restructuring.
For the owner, this means the two lenders arrive at a hard conversation with opposite interests. The first-out holder is covered by the collateral and cash flow and may prefer a quick sale or strict terms that protect its principal. The last-out holder is exposed and may prefer to give the company time, provide new money or take control rather than accept a loss. A covenant waiver or forbearance can stall while the lenders settle their positions between themselves. What to do when you breach a covenant covers the borrower's side of that negotiation.
Because the borrower is often not a party to the agreement among lenders, how a bankruptcy court treats it is less settled than a conventional intercreditor agreement. For an owner, the practical point is simpler: in a serious downturn, expect the lenders to spend time on each other before they spend time on the company.
In a FOLO, a waiver is only as quick as the slower of two lenders with opposite interests.
When FOLO appears, and when it does not
FOLO shows up most often in these situations:
- A company's bank wants to keep the relationship and the revolver but will not lend as much as the deal needs, and a credit fund will take the rest.
- An acquisition or recapitalization needs more than senior leverage, and the buyer wants one set of documents rather than a senior loan and a junior loan.
- A credit fund leads the deal and sells the first-out piece to a bank to lower its own cost of holding the loan, passing some of the saving to the borrower.
- A delayed draw facility for future add-ons sits inside the unitranche, and the lenders want to fix in advance how new draws rank.
It rarely appears in smaller deals. Where an SBA 7(a) loan fits the transaction, up to the $5 million program limit, or where a single bank can fund the whole senior need, there is no slice for a fund to take. It also fits poorly where the company expects to need frequent amendments, because every material change becomes a three-party conversation. Who lends to lower-middle-market companies lays out which lenders show up at which size.
Questions to ask before you sign
- Who holds the first-out piece and who holds the last-out, and how large is each?
- Is the split only in the agreement among lenders, or is it written into the credit agreement as two tranches with two rates?
- What are the trigger events that switch the payment waterfall, and does a covenant default count?
- How is required lenders defined, and which amendments need the consent of both pieces: pricing, maturity, the size of the first-out piece, releases of collateral?
- Who controls enforcement after a default, for how long, and does the last-out holder have a right to buy out the first-out?
- Who is the agent, and does it hold a piece of the loan itself?
Lenders will not always hand the borrower the agreement among lenders, but they will usually answer these questions in writing. The answers belong in the file before the term sheet is signed, not after the first missed covenant. The difference between a term sheet, a commitment letter and a credit agreement explains when each of these terms becomes binding.
Of the 1,800+ lenders in Transparent's book, 1,148 write term and private credit, the group from which both halves of a FOLO come. Transparent's lender package puts one financing model in front of every lender, so a FOLO offer can be compared with a senior-plus-junior offer on the same figures rather than on headline rate. See how we underwrite for how those figures are built.
Common questions
- Is a first-out/last-out unitranche cheaper than a regular unitranche?
- Often, because part of the loan is priced at bank returns rather than fund returns, which lowers the blended rate. It is not always cheaper once call protection and fees are counted, and it adds a second lender to any future amendment.
- Can I see the agreement among lenders?
- Not always. The borrower is often not a party, and lenders may treat it as confidential. Ask for its key terms in writing: the trigger events, the voting rules, who controls enforcement and whether the last-out can buy out the first-out.
- Does the first-out lender have to be a bank?
- No. It is often a bank, because the lower-risk, lower-return position suits a bank's cost of funds, but any lender willing to take that position can hold it, including another fund.
- Is FOLO the same as first lien and second lien?
- No. In a first lien/second lien structure there are two loans, two credit agreements and an intercreditor agreement the borrower signs. In a FOLO there is one loan and one lien; the priority between lenders is set by their own agreement.
- What happens to my rate if I prepay part of a FOLO loan?
- If the split lives only in the agreement among lenders, nothing: the one rate applies to whatever balance remains. If the credit agreement shows two tranches, prepaying the cheaper tranche first raises the blended rate on what is left.