What it means
A struggling company often cannot raise money in the ordinary way, since lenders worry they will not be repaid. To persuade someone to lend, the company can offer a first claim on its assets, ahead of every other creditor.
That new first-ranking loan is a priming loan. In some legal systems the best-known use is in court-supervised restructuring.
In the United States, for example, a company in Chapter 11 can ask the court to approve what is called debtor-in-possession financing, and in some cases the court can give the new lender a priming lien over assets already pledged to others. The court will normally require that existing lenders are adequately protected.
The new lender gets strong protection and often charges high interest and fees to reflect the situation. Existing lenders see their ranking fall, which may reduce what they recover.
They may object, negotiate better terms or agree to provide the financing themselves so that they keep control of the outcome. Priming loans can save a business that would otherwise collapse, because they pay for wages, suppliers and operating costs while a restructuring is worked out.
If the business survives, the loan is repaid first, and everyone else benefits from the value preserved. If it fails, the primed lenders may bear a bigger loss than they would have without the loan.
Outside formal insolvency, priming can also be arranged by agreement, through a refinancing in which some lenders swap into a new, higher-ranking loan and leave others behind. Such deals can be controversial because lenders who are left out feel their position has been weakened.
Pricing reflects the risk and the speed. Priming lenders often charge interest well above normal rates, plus arrangement fees, and they usually insist on tight budgets and regular reporting.
Managers should understand that the cost is high and that the money is meant to bridge a specific period, not fund the business indefinitely.
In practice
Real-world examples.
Example
A shipping company in restructuring obtains $30,000,000 of emergency finance that ranks ahead of its existing bank loans. The money pays crew and fuel costs while a sale of vessels is arranged. The lenders insist on weekly cash reports during the process.
Example
A group of lenders to a technology company agrees to provide a new loan that ranks first and to move their old loans down. Other lenders who are not part of the group object that their position has been weakened without their consent.
Example
A retailer uses a priming loan secured on its stock to survive the weeks before a peak sales season. Sales cover the loan and the business emerges with a smaller debt burden. The new lender is repaid out of the proceeds of the season's sales.
Formula
Calculation
Recovery for the existing lender = The lower of (Existing claim) and (Asset value - Priming loan), and Recovery for the priming lender = The lower of (Priming loan) and (Asset value).
A company's assets are worth $12,000,000 in a forced sale. It owes an existing first-ranking lender $9,000,000 and raises a priming loan of $5,000,000. The priming lender is repaid first, so it recovers the lower of $5,000,000 and $12,000,000, which is the full $5,000,000.
The existing lender recovers the lower of $9,000,000 and ($12,000,000 - $5,000,000) = $7,000,000, which is $7,000,000 / $9,000,000 = 77.8% of its claim. Before the priming loan it would have recovered the full $9,000,000, so the loss caused by priming is $2,000,000 in this case.Case study
Seen in the real world.
Ashford Textiles is a fictional clothing manufacturer owing $9,000,000 to its bank, secured on factory equipment and stock. After a failed product line, it could not pay its suppliers and sought $5,000,000 of fresh funds.
An illustrative specialist lender offered the money only if its loan ranked first. The bank objected, arguing that its recovery would fall from 100% to about 78%, but the court accepted that without the loan the company would have to close and the assets would fetch far less.
The fictional business used the funds to complete its orders and returned to profit under a restructuring plan. The priming lender was repaid in full, and the bank recovered more than it would have in a shutdown, which is the usual argument in favour of such loans.
Watch out
Common mistakes.
- Believing a priming loan is always bad for existing lenders, when it can protect the value of the business and improve their eventual recovery.
- Overlooking the cost of priming finance, which usually carries high interest and fees.
- Treating priming as available in every country, when insolvency laws differ widely.
Questions
People also ask.
Why would a company take a priming loan?
Because it may be the only way to get emergency funding while keeping the business running.
How are existing lenders protected?
Through loan covenants, court oversight and requirements that their interest be adequately protected.
Is a priming loan the same as debtor-in-possession financing?
Often they overlap, since much priming finance is provided to companies in court-supervised restructuring, but priming can also be arranged by agreement outside the courts.
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