Corvanta Telecom's group needs Rs 500 crore. Should a lender lend at the holding company or with a guarantee from the operating company, which already has Rs 1,200 crore of debt? Test it in a downside where group value falls to Rs 1,400 crore.

At the holding company the new lender recovers 40%; with an operating company guarantee it recovers about 82%. Unguaranteed, it is structurally subordinated: the operating company's Rs 1,200 crore is paid first and only Rs 200 crore passes up. With the guarantee, Rs 1,400 crore is shared across Rs 1,700 crore of claims. Take the guarantee, but expect the existing lenders to resist, because their recovery falls from 100% to about 82%.

A holding company owns shares, not towers. Think of lending to a parent whose only asset is a stake in a child's shop: if the shop fails, its suppliers are paid from the shop's stock first, and the parent gets whatever is left. A lender to the holding company is paid only from the equity value left after every operating company creditor is paid in full, which is structural subordinationLenders to a parent rank behind all creditors of its subsidiaries, because the parent owns only shares in them.. In the downside that equity value is Rs 1,400 crore less Rs 1,200 crore: Rs 200 crore, 40% of the new loan.

A guarantee from the operating company gives the new lender a direct claim on the operating company's assets, ranking alongside the existing banks. Recovery jumps from 40% to 82.4%, but the value comes from somewhere: the existing operating company lenders fall from 100% to 82.4%. Nothing new is created; the same Rs 1,400 crore is re-cut. Group leverage is 4.25x either way.

The existing loan documents. Operating company lenders almost always restrict new debt, guarantees and security at the operating company, precisely to protect their position, so the guarantee needs their consent. Cash flow is also a problem at the holding company: it services its loan from dividends, which operating company lenders can block if ratios slip. Structural subordination hits a holding company lender twice, first on cash flow and then on recovery.

The view: lend with the operating company guarantee and negotiate consent, perhaps by sharing security and a common intercreditor agreement. If consent is refused, lend at the holding company only at a price that reflects a 40% downside recovery, with a pledge over the operating company's shares and a cap on operating company debt. Where upstream guarantees are used, confirm that local company law permits them and that they are for the guarantor's corporate benefit.