A junior equity is any type of equity that is considered subordinate to another equity issued by the same entity. One of the most common examples of this type of investment situation has to do with the issuance of common and preferred stock by the same company. In matters such as the extension of dividend payments to investors, those holding preferred stock would be compensated first, while those holding common stock as a junior equity would be compensated afterward.
The concept of junior equity also relates to situations in which the issuing company experiences some type of financial distress. Should a business declare bankruptcy, the court of jurisdiction will address other claims on the assets of the company before considering the claims of anyone holding a junior equity. For example, if the junior equity in question is shares of common stock, the court will address the claims of vendors who are holding outstanding debts against the business, then the claims of any investors holding bonds issued by the company, followed by the claims of investors holding preferred stock. Only after these other claims have been settled will the court move on to the claims made by those holding shares of common stock.
Another characteristic of a junior equity is that the investor who owns shares of a subordinate stock typically receives dividends based on the profitability of the issuing company. There are no guarantees that owning the shares of stock will actually result in the realization of dividends, since there are no guarantees that the company will turn a profit in every dividend period. This is in contrast to preferred shares of stock, with which shareholders do have at least some guarantees of earning some type of dividend even if the company does not post a profit for a given period.
While a junior equity is subordinate to other types of debt obligations, that does not mean that this type of security cannot be lucrative. Assuming a company that is financially stable and is consistently earning a profit issues the shares, the chances of receiving dividends is highly likely. The real concern with a junior equity has to do with situations in which the issuing entity undergoes a financial reversal, such as losing market share to a competitor. In that scenario, dividend payments will be lower and possibly not be provided at all until the company is able to increase demand for its products.
