The difference between subordinated debt and senior debt is the priority in which the debt claims are paid by a firm in bankruptcy or liquidation. If a company has both subordinated debt and senior debt and has to file for bankruptcy or faces liquidation, the senior debt is paid back first before the subordinated debt. Once the senior debt is completely paid back, the company then repays the subordinated debt.
There is risk, however, that a company is not able to pay back its subordinated debt due to the fact it probably does not have much money and is obligated to pay back the senior debt first. Therefore, it is more advantageous for a lender to own a claim on a company’s senior debt than on subordinated debt.
If a company files for bankruptcy, the bankruptcy courts prioritize the outstanding loans in which the company’s liquidated assets are used to repay; any debt that has a lesser priority over other forms of debt is considered subordinated debt. Any debt with higher priority over other forms of debt is considered senior debt.
For example, if a company has debt A that totals $100 and debt B that totals $50, debt A is senior debt and debt B is subordinated debt. If the company needs to file for bankruptcy, it is required to liquidate all of its assets to repay the debt. If the company’s assets are liquidated for $125, it first needs to pay off the $100 amount of its senior debt A. The remaining subordinated debt B is only half repaid due to the lack of money.