Subordinated Lenders: How Do They Work?
Most lenders want first position, but not all of them need it. Here is how second-position and subordinated lending works, why it exists, and how Canadian businesses use it to access capital without disturbing their existing bank facility.
Why security position matters in commercial lending
In commercial lending, priority matters. When a business borrows money, lenders want to know exactly where they stand in the repayment line if something goes wrong. Most lenders insist on being in first security position, the top spot with the strongest claim over the borrower's assets.
What many Canadian business owners do not realise is that not all lenders need to be first in line. A growing segment of the market is willing to lend in second position, behind an existing senior lender. These subordinated lenders play a crucial role in helping businesses access additional capital when traditional bank financing alone is not enough.
Why most lenders require first position
A lender in first position holds the primary security interest over the borrower's assets. If the business defaults, the first-position lender gets paid before anyone else. This reduces their risk and typically allows them to offer:
- Lower interest rates reflecting their stronger security position
- Longer repayment terms and greater facility size
- More predictable, standardised lending criteria
Banks, credit unions, and most institutional lenders almost always require first position. It is a core part of their risk management model, and the reason their pricing tends to be more competitive.
How second-position lending works
A second-position lender, also called a subordinated lender or junior lender, agrees to take a security interest behind the first lender. This means:
- They get paid after the first lender in a liquidation or default event
- They carry more risk, and price their facilities accordingly
- They allow businesses to layer additional capital on top of existing senior debt
Despite the increased risk, these lenders fill an important gap in the Canadian market. They enable businesses to access further capital without disturbing the primary bank relationship or refinancing the entire debt structure.
Second-position lending makes it possible to layer financing, keeping your bank relationship intact while unlocking additional growth capital.
Who lends in second position, and why
Second-position lenders typically include private lenders, mezzanine finance providers, asset-based lenders, specialty finance companies, and certain alternative funders. They are comfortable operating behind a senior lender because they:
- Price their facilities to reflect the additional risk they carry
- Rely on strong business cash flow, collateral coverage, or personal guarantees
- Understand that most established businesses already carry senior bank debt
- Structure deals creatively to protect their downside position
For these lenders, second-position financing is a deliberate strategic niche, one that banks and institutional lenders rarely enter.
When businesses use subordinated financing
Second-position loans are particularly useful for businesses that:
- Need growth capital beyond what their primary bank will provide
- Are acquiring another business or funding an expansion
- Require working capital support without replacing an existing facility
- Have strong cash flow but have reached their senior borrowing capacity
- Want to avoid the disruption and cost of refinancing their entire debt structure
Instead of replacing the first lender, the business layers the new financing on top, preserving the existing bank relationship and its favourable terms while accessing the additional capital needed to move forward.
The intercreditor agreement
When a second-position lender comes in behind an existing senior lender, the two parties typically enter an intercreditor agreement. This document establishes:
- The order in which each lender gets paid in a default or winding-up scenario
- How collateral and security is shared between the two lenders
- What actions each lender can take, and when, if the borrower gets into difficulty
- Any restrictions on the borrower taking on further debt
The intercreditor agreement is what makes the layered structure workable. It gives all parties, borrower, senior lender, and subordinated lender, clarity on the rules of engagement before any capital is deployed.
Subordinated lending vs. other financing options
Subordinated lending is one tool in a broader set of commercial finance options. Depending on your situation, a flexible line of credit or a structured term loan behind your existing bank facility may serve the same purpose, providing working capital or growth funding without replacing your senior debt.
For businesses with strong receivables, invoice factoring can also provide working capital without adding to the formal debt stack at all, an approach that sidesteps the intercreditor conversation entirely.
Is subordinated financing right for your business?
The lending landscape is broader than most business owners realise. If your primary lender cannot increase your facility, or if you need capital that does not fit the bank's credit box, a subordinated or second-position lender may be the key to unlocking your next stage of growth.
Understanding your options before you need capital is always better than searching under pressure. If you would like to explore whether a layered financing structure makes sense for your business, start a conversation with McMillan Capital Partners.
Common questions
A subordinated lender, also called a second-position or junior lender, agrees to take a security interest behind an existing senior lender. In the event of a default or liquidation, the senior lender gets paid first. The subordinated lender accepts this position in exchange for higher returns on their capital.
Businesses use subordinated lending when they need additional capital beyond what their primary bank will provide, but do not want to refinance their entire debt structure. It allows them to layer new financing on top of existing facilities, preserving the bank relationship and its terms while accessing the growth capital they need.
An intercreditor agreement is a contract between a senior lender and a subordinated lender that defines the order of repayment, how security is shared, and what actions each party can take if the borrower defaults. It is a standard part of any layered lending structure and gives all parties clarity before funds are advanced.
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