Borrow where the cash and assets are, or make sure the lender can reach them. A loan to the operating company, or to a holding company with guarantees and liens from the operating company, sits directly against the business's cash flow and assets. A loan to the holding company alone is structurally subordinated: it can be repaid only from what the operating company pays up after its own creditors are satisfied, and only when the operating company's lenders allow it. Lenders therefore price holdco-only debt as junior capital, whatever it is called.
- Opco debt
- A direct claim on the business's cash flow and assets
- Holdco debt with opco guarantees
- Treated much like opco debt, if the guarantees and liens hold
- Holdco debt alone
- Structurally subordinated to every opco creditor
- What limits holdco debt service
- The opco loan's restrictions on dividends to the holdco
- SBA's approach
- The operating company goes on the loan, commonly as co-borrower
Why the entity on the loan matters
Many private businesses are owned through a holding company. A buyer forms a holdco to make the acquisition; a founder uses one to own several businesses or to hold real estate separately. The operating company, the opco, has the customers, employees, receivables, equipment and cash. The holdco owns the opco's shares and, usually, little else.
A creditor can only collect from the entity that owes it, and from anyone who has guaranteed the debt. A lender to the holdco alone has a claim on the holdco's assets, which are the opco's shares. Those shares are worth only what is left of the opco after the opco's own creditors, its lenders, suppliers, landlord, employees and tax authorities, have been paid. That position is called structural subordination, and it is why lenders care intensely about which entity signs.
The structures, and where each lender stands
| Structure | What the lender can reach | How lenders tend to treat it |
|---|---|---|
| Opco is the borrower; holdco guarantees and pledges the opco's shares | The opco's cash flow and assets directly, plus control of the shares | Senior debt; the standard structure for bank and cash-flow loans |
| Holdco is the borrower; opco guarantees and grants liens on its assets | The opco's assets through the guarantee and liens | Senior debt, provided the guarantee and liens are enforceable |
| Holdco and opco are co-borrowers, jointly and severally liable | Either entity, for the whole debt | Senior debt; common where lenders and SBA want the operating business directly liable |
| Holdco is the borrower; no opco guarantee, only a pledge of opco shares | Whatever value remains in the opco after its creditors | Junior capital: priced and structured like mezzanine or holdco notes |
| Holdco is the borrower, unsecured | A general claim against a company whose only asset is the opco's shares | The most junior position in the group |
Structural subordination, in numbers
Suppose the opco fails and its assets are sold for 1,000. It owes its senior lender 600, secured on its assets, and owes 250 to suppliers, employees and other unsecured creditors. A second lender has lent 400 to the holdco.
- Holdco loan with no opco guarantee: the senior lender takes 600, the opco's other creditors take 250, and the remaining 150 flows up to the holdco as the value of its shares. The holdco lender recovers 150 of its 400.
- Holdco loan with an unsecured opco guarantee: after the senior lender's 600, the holdco lender's 400 claim ranks alongside the 250 of other unsecured claims against the remaining 400. It recovers roughly 246, most of what remains, instead of the leftovers.
- Holdco loan with an opco guarantee secured by a second lien: after the senior lender's 600, the holdco lender takes the remaining 400 ahead of the unsecured creditors.
Same borrower, same loan amount, three very different outcomes. The difference lies entirely in whether the lender can reach the opco. That is the whole case for opco guarantees, and why a holdco-only lender demands the return of junior capital. See first lien vs second lien and intercreditor agreements.
A holdco loan that cannot reach the operating company is junior debt, whatever its documents call it.
Getting cash up to the holdco
Structural subordination is not only a problem in a default. Every payment on holdco-only debt depends on the opco sending cash up, as a dividend or distribution, and the opco's lender controls that. Loan agreements carry restricted-payment covenants that limit distributions, typically allowing:
- Tax distributions, so owners of a pass-through entity can pay tax on the opco's income; see tax distributions under a loan.
- Modest amounts for the holdco's own overhead.
- Payments on permitted holdco debt, often only while no default exists and a leverage or coverage test is met.
- Other distributions only from a defined basket, if any.
When the opco lender's test fails, the tap closes and the holdco lender is not paid, even if the opco itself is still current on its own loan. That is why holdco debt without opco support is often structured with PIK interest, which accrues rather than being paid in cash, and why its lenders ask for equity-like returns. It is also why a senior lender at the opco will look through to holdco debt: payments the owners must make upstairs are a claim on the same cash flow, and they show up in the lender's reading of fixed charge coverage and total leverage.
How lenders take guarantees and collateral across a group
A senior lender to a holdco group typically asks for the full set: the opco as borrower or guarantor, a lien on the opco's assets, a pledge of the opco's shares by the holdco, and a guarantee from the holdco. Where the group has several operating companies, each usually joins the loan as a joint and several borrower or guarantor, and the covenants are tested on consolidated figures.
Several things can complicate it, and lenders ask about each early:
- Minority owners in an opco. A partly owned subsidiary that guarantees its parent's debt puts its other owners' value behind a loan they do not share in, so those owners may need to consent.
- Solvency of the guarantor. Guarantees given upstream, by a subsidiary for its parent's debt, are tested against the guarantor's solvency and the benefit it received; lenders' counsel sizes them to hold up.
- Other lenders' liens. An equipment lender, a factor or a landlord may already have claims on part of an opco's assets. The new lender will want payoffs, carve-outs or an intercreditor agreement.
- Real estate in a separate company. A property company that leases to the opco is often kept out of the operating loan and financed on its own; see propco and opco structures.
- Licenses and contracts. Some licenses, payer contracts and government contracts cannot be pledged or restrict changes of control, which limits what a lender can take.
For a line of credit or asset-based loan, the entity question is sharper: each borrower's receivables and inventory go into its own borrowing base, and an opco that is not a borrower contributes nothing to availability; see how a borrowing base works.
SBA and holding companies
SBA lends to operating businesses. When a holdco buys a business with a 7(a) loan, SBA lenders put the operating company on the loan, commonly as co-borrower, so the entity generating the cash is directly liable. Ownership held through the holdco counts for guarantees: every owner of 20% or more personally guarantees an SBA loan, whether they own directly or through another company. SBA also looks at a borrower and its affiliates as a group for its size standards and loan limits; 7(a) loans go up to $5 million, and SBA's guaranty to one borrower is capped at $3.75 million. Real estate can sit in an eligible passive company that leases to the opco, with the opco on the loan. See holding company structure for acquisitions.
Deciding where to borrow
For a single operating business, the answer is almost always the same: the senior loan sits at the opco, or at the holdco with full opco guarantees and liens. The holdco exists for ownership, tax and future flexibility, not to change where the lender stands.
Holdco-only debt has a place, usually as a junior layer that the owners choose to keep away from the opco's lender, such as a note funding part of an acquisition or a dividend recapitalization. It works only when the opco lender's documents permit it and the opco can send up enough cash under its restricted-payment terms, and it costs what junior capital costs. Owners weighing it against an opco-level second lien or mezzanine loan will find the trade-offs in mezzanine debt in the lower middle market.
Groups planning more acquisitions should set the structure with the first lender, so later companies can join as borrowers or guarantors without renegotiating the loan; see add-on acquisition financing. Transparent's financing model lays out each entity's cash flow, the guarantees and liens across the group, and the distributions the holdco needs, so a lender reads the structure from the first page; see the package.
Common questions
- Will a lender lend to my holding company?
- Yes, usually with the operating company guaranteeing the loan and granting liens on its assets, or as co-borrower. A lender asked to lend to the holdco without any claim on the operating company will treat the loan as junior capital and price it that way.
- What is structural subordination?
- The position of a creditor of a parent company relative to creditors of its subsidiary. The parent's creditors can reach the subsidiary's value only through the parent's shares, after the subsidiary's own creditors are paid, unless the subsidiary has guaranteed the parent's debt.
- Can the operating company pay the holding company's loan?
- Only as far as its own lender's restricted-payment covenants allow, typically tax distributions, some overhead and permitted debt service while no default exists. If the opco's loan tightens, payments to the holdco can stop.
- Does a holding company let an owner avoid a personal guarantee?
- Not on an SBA loan: every owner of 20% or more personally guarantees, including owners through another company. On conventional loans, guarantees are negotiated on the credit, not on the entity chart.
- Should each operating company in a group have its own loan?
- Sometimes, for example where one company has real estate or specialized equipment financed separately. More often a single facility with every operating company as borrower or guarantor gives more capacity, because the lender can rely on the whole group's cash flow and assets.