Structuring the loan. One of the main aspects of mitigating structural risk is properly identifying where the loan will be made, meaning what is the exact borrowing entity and where is it in the organizational structure? Structural subordination is when debt at the subsidiary level has higher claim on assets than debt at the parent or group level. This is why an issuer rating is no longer helpful. It is only the issue rating that deals with the loss on default of a specific loan. Without that proper structure, there is a risk of greater loss or total loss. Corporations are rarely just one entity but rather groupings of subsidiaries. It is typically at the sub-level that the assets and cash flow exist, while the stock or ownership is at the company level. Furthermore, in complex transactions, SPV or special purpose vehicles are often set up exclusively for the financing. They have no revenues or assets of their own and rely purely on downstream entities to pass through cash flow. Guarantees, which are a major feature of the term sheet can properly mitigate the risk in a complex structure by having one legal structure guarantee the debt of another. Now, we will look at an example of a corporate structure, holding companies or holdcos are generally the parent companies that own stock in the subsidiaries, also known as opcos. Where to lend within the structure matters, both holding cos and opcos and a corporate structure can borrow debt holdcos own equity in an opco and have the lowest claim on an opco's assets without guarantees of course. Guarantees in pledges or negative pledges, which will be discussed later, are the best way to establish firm structure. This is a corporate structure from a previous LBO transaction. Here we see the financial sponsor group in the upper left and the management team in the upper right, both contributing equity and therefore owning the holding company. The HoldCo is guaranteed, most likely via pledge of stock, the loans which are made to the parent corporation, NPC International Inc, which has 100% ownership of the opcos, in this deal, the loans were made to the opcos and the parent, most likely with restrictions on additional debt, dividends, asset sales, et cetera, so that the banks can be sure that nothing floats to the top without their knowledge. Now here's a much more complicated structure that is virtually impossible to imagine. This is not uncommon, particularly in leveraged buyouts, although it is way behind the level of this course. If we do look closely at it, we'll see some of the attributes though, of a well-structured set of loans coming into play, guarantees of debt, asset security and stock pledges all over the structure.
