Debt Restructuring And Debt-For-Equity Swaps
By Tarun Jaswani
Debt restructuring is a process that allows a private or public company - or a sovereign entity - facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations. Debt restructuring may occur out of court, or through a court-mediated debt restructuring agreement that may provide for a partial waiver of debts, or for a liquidation of the debtor's assets by the creditors.
Debt is a negative quantity of wealth that originates in a transfer of wealth in which the owner does not immediately receive compensation in wealth. It is goods or services owed to a creditor; usually referencing assets owed, but the term can cover other obligations. In the case of assets, debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.
A debt is created when a creditor agrees to lend a sum of assets to a debtor. In modern society, debt is usually granted with expected repayment; in many cases, plus interest. Historically, debt was responsible for the creation of indentured servants.
Out-of court restructurings, also known as workouts, are increasingly becoming a global reality. A debt restructuring is usually less expensive and a preferable alternative to bankruptcy. The main costs associated with a business debt restructuring are the time and effort to negotiate with bankers, creditors, vendors and tax authorities. Debt restructurings typically involve a reduction of debt and an extension of payment terms.
In the United States, small business bankruptcy filings cost at least $50,000 in legal and court fees, and filing costs in excess of $100,000 are common. By some measures, only 20% of firms survive Chapter 11 bankruptcy filings.
Debt-for-Equity Swaps
In a debt-for-equity swap, a company's creditors generally agree to cancel some or all of the debt in exchange for equity in the company.
Debt for equity deals often occur when large companies run into serious financial trouble, and often result in these companies being taken over by their principal creditors. This is because both the debt and the remaining assets in these companies are so large that there is no advantage for the creditors to drive the company into bankruptcy. Instead the creditors prefer to take control of the business as a going concern.
As a consequence, the original shareholders' stake in the company is generally significantly diluted in these deals.
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