Glossary - First-Loss Position
The first-loss position is a scenario in financial investments where a party agrees to absorb the initial losses up to a certain threshold before any losses are allocated to other stakeholders. This is often seen in investment structures where a party wants to incentivize others to participate by providing a form of cushion against potential losses. This term is applicable in contexts where investments carry a risk of partial or total loss, and one party wishes to reassure investors by taking on the riskiest part of the investment.
Also known as
- First-Loss Guarantee
- Loss-Absorption Layer
Use cases examples
- Investment Agreement: The investor agrees to occupy the first-loss position, absorbing up to 10% of any initial portfolio losses before any losses are passed onto other investors.
- Loan Agreement: In case of default, the guarantor will cover the first 5% of losses, acting in a first-loss position, before the principal lender seeks repayment from collateral.
Considerations for investors
- Evaluating the risk-reward ratio of taking a first-loss position, considering it might entail higher risks for potentially higher returns.
- Carefully structuring the agreement to clearly define the conditions under which the first-loss provisions are triggered to avoid any potential disputes.
Considerations for founders
- Assessing the willingness and capability of a party proposing to take a first-loss position as it can significantly impact the financial stability of the business.
- Understanding the legal and financial implications of agreeing to a structure that includes a first-loss position, especially how it affects cash flow and liability in adverse situations.
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