If your business is facing financial difficulties that may be short-term, a debt-for-equity swap could be a beneficial refinancing deal for you.
A debt-for-equity swap is where a company or individual debt can be exchanged for something of value, i.e., a share of the business (equity).
At Direct Route, we always advise that if your business is facing financial difficulties, you speak with your lender and ask for help and further information regarding refinancing options.
Used as a form of financial restructuring, a debt for equity swap is a way to renegotiate debt so that the creditor will receive an equity interest in the company in exchange for the cancellation of the debt.
(For those operating as a plc, debt can be exchanged for bonds of stock. The value of these stocks and bonds that are to be exchanged will be determined by the market at the time of the swap.)
The biggest reason why businesses opt to exchange equity for debt is to write off the money owed to creditors – typically sought during bankruptcy stages.
Debt equity trade
When discussing debt equity, we talk about exchanging a percentage share of the company to cancel out the remaining debt.
A typical option for companies in financial distress who are suffering cash flow problems, business losses, or experiencing a sudden decline in revenue.
In cases of late payment of commercial debt, financing requirements such as debt-equity ratios can be imposed by lenders as well as used as part of bankruptcy restructuring – for example, under Chapter 11 of bankruptcy proceedings, a business can continue operating while it begins the process of restructuring its finances.
If a company can no longer repay its debts or certainly not in the pre-agreed period of time, then the lender may consider swapping the debt for an equity position in the company.
However, this is only viable if the lender believes cancelling the debt will help the company continue operating.
Why opt for a debt-equity swap?
The main reason why a business offers debt holders equity is when the business finds that it is unable to pay the current face value of the debt.
To help delay repayments, businesses offer stock in exchange and, as such, will require a debt-for-equity swap agreement. This agreement will outline formal amendments you would like to make to an existing loan.
To help with business debt settlement, debt equity can work to make trades more enticing, and allow businesses to continue operating.
Note: In bankruptcy cases, the debt holder often won’t have a choice if a debt/equity swap is an option.
Who benefits – debt for equity swap
There are benefits to both the creditor and the debtor in debt-equity swaps, for example:
For the debtor company:
- Helps struggling companies continue to operate
- It provides an opportunity for financially struggling companies to restructure
- Helps to weather out financial difficulties
- Can maintain a positive credit rating
- Most cost-effective way to obtain much-needed capital
For creditors:
- If this is simply a short-term financial problem that the company is facing and there are still long-term commercial benefits, this can significantly benefit creditors.
- It avoids creditors having to take further action, i.e., court proceedings for late payment of commercial debt.
- Creditors will receive some form of payment, which can be significant, especially if the company falls into insolvency.
Things to consider
Not everything is plain sailing with debt-equity swap. There are a lot of moving parts and areas to consider. For example, the company must get buy-in from creditors; in addition, existing shareholders will be diluted, so achieving shareholder approval may be difficult, and implications for the business and its staff may be challenging.
You will also need to consider how much debt will be converted into equity, what the current position is with other creditors (you can’t offer everyone everything, do you have a planned strategy to move forward), is there any existing shareholder debt (how will you manage this?), and what are, and will there be any tax implications.
Companies must also think about the costs associated with converting debt to equity (as you may incur a higher financial price than the outstanding loan balance), if debtors/companies can avoid personal guarantees, how much control remains in the company, and more.
Commercial debt recovery
Equity swaps for debt must be carefully thought through and planned. You will need to agree to new and realistic finance restructuring plans.
While all of these negotiations are ongoing, lenders will agree that no action will be taken to continue to enforce the loan/debt.
However, it’s important to note that this solution may not always solve the problem.
At Direct Route, we help with all forms of credit control processes. Supporting businesses collecting unpaid debts and late invoices, we offer practical and effective solutions tailored to your requirements.
To find out more, call us at 01274223190 or email: memberbenefits@directroute.co.uk