Introduction
In today’s credit environment, we are seeing strong borrower demand for layered debt structures that combine first and second lien credit facilities. These structures offer flexibility and cost efficiency by pairing two lenders with complementary risk-return profiles. Typically, a revolving lender—often a bank or credit fund—holds the first lien and may also provide term debt, while a second lien lender seeks higher yield in exchange for taking on more risk. This approach is especially prevalent in the lower middle market, where it has a solid track record of aligning incentives and delivering favorable outcomes for all parties.
That said, borrowers should be mindful of potential friction points: documentation costs can exceed expectations, intercreditor dynamics may become complex, and inconsistencies between lien loan documents can create legal ambiguity. With thoughtful structuring and proactive coordination, these risks can be effectively managed—making first/second lien structures a compelling option for borrowers.
Assessing Borrowing Needs
Borrowers should collaborate closely with their financial advisors to evaluate credit requirements and forward-looking capital needs. In most cases, this analysis does not start from scratch—often there is an existing lending relationship in place. As a result, structuring new debt may involve either (a) a full refinancing with payoff letters and releases, or (b) layering new debt into the capital stack—such as adding a first lien loan that sits senior to existing debt, or a second lien loan that is contractually subordinated.
Even with input from experienced advisors, borrowers may not initially know which structure best fits their objectives. These decisions often take shape through early-stage discussions with potential lenders, where market feedback helps clarify the most viable and efficient path forward.
Term Sheets
Once a borrower has assessed its credit needs, the next step typically is to reach out to multiple potential lenders to gauge market appetite and solicit non-binding term sheets. These initial proposals are based on a high-level review of the borrower’s financials, collateral, intended use of proceeds, and other key factors—giving lenders a clear sense of what structures they can support.
At this stage, borrowers often explore bifurcated structures involving separate first and second lien lenders. The presence of multiple lienholders significantly influences credit analysis and deal dynamics. If a dual-lien structure is pursued, it is critical that the borrower transparently communicates this to all parties and ensures that proposed term sheets include key intercreditor terms.
Addressing intercreditor mechanics early—at the term sheet stage—helps align expectations, reduces downstream legal costs, and minimizes the risk of conflicting provisions in final lien loan documentation. In nearly all cases, negotiating these points upfront leads to a more efficient and executable transaction.
Documentation Considerations
Documenting first and second lien facilities presents two primary challenges: (i) negotiating the intercreditor agreement and (ii) ensuring alignment between the first and second lien loan documents. Focusing on the latter, borrowers should aim to avoid conflicting provisions across the two sets of documents. For example, differing notice requirements between the first and second lien agreements can create confusion and compliance risk.
The most efficient approach is often to finalize the first lien document set with the senior lender and then mirror those terms in the second lien documents. While not always feasible, this strategy minimizes the cost and complexity of negotiating two independent sets of lien loan documents and helps ensure consistency. For all parties involved, aligning key terms early in the process reduces friction, shortens timelines, and lowers legal expenses.
Conclusion
Successfully structuring, negotiating, and documenting first and second lien facilities requires thoughtful planning to avoid unnecessary complexity and cost. Key strategies include:
- Aligning lenders early by negotiating coordinated term sheets that incorporate intercreditor provisions;
- Streamlining documentation by first finalizing one set of loan documents—typically the first lien—and using it as a template for the second lien; and
- Allowing sufficient time to execute these steps without compromising deal quality.
While the pressure to close quickly can sometimes overshadow planning, taking a disciplined approach upfront often leads to smoother execution and better outcomes. Shields Legal Group is well-positioned to support borrowers at any stage of this process, helping protect your business and maximize deal efficiency.
