Debt restructuring is less expensive for a company

By Odhiambo Ocholla

Debt restructuring allows a company facing cash flow problems to reduce and renegotiate its debts in order to improve or restore liquidity position.

Debt restructuring is when a company is facing liquidity issues, and attempts to negotiate with its creditors to change the terms of loans in order to continue business operations. It is always a better option for a company because it allows it to stay in business without having to go through liquidation.

The goal of debt restructuring is not to write off a company’s debt, but rather lower the interest payments and extend the terms of the loan to get through a rough patch. Companies attempting to go through a debt restructuring must first prove that their current market environment will ultimately pass, and the company will be able to return to profitability. This is what makes debt restructuring deals challenging, because companies have to convince creditors and bankers that the company will be able to make good on the new finance arrangements within a specified period of time.

Unfortunately, for many businesses, reducing debt is not as easy as it appears. In fact, many companies immediately feel frustrated after realising how difficult the process can be.

Difficult challenges

Debt restructuring requires honed skills, resources, strategies and skilled personnel to take on the most difficult challenges and obstacles that many businesses face in regards to debt. The process requires effective methods to manage and control it appropriately. It’s important to note that debt restructuring does not tarnish a company’s credit worthiness, so the company is able to still receive financing to make payroll, purchase supplies and even expand the business in more profitable areas.

Some companies and corporations use debt as a part of their overall corporate finance strategy. 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 restructuring is usually less expensive, and a preferable alternative to liquidation. The main costs associated with a business debt restructuring are the time and effort to negotiate with bankers and creditors.

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.

A debt to equity swap is where a lender agrees to reduce the amount of debt it is owed by the borrower by agreeing to subscribe for new shares in the borrower equal to the value of the reduction of the debt.

As a consequence, the borrower will issue new shares to the lender thereby increasing the total number of shares in issue in the borrower and the outstanding debt will either be reduced or eliminated depending on the agreed level of swap. The original shareholders’ stake in the company is generally significantly diluted in these deals.

The debt to equity swap benefits a company through the boost to cash flow, which results from the reduction of ongoing principal repayments and interest costs.

However, it should also be noted that debt to equity swaps can be complex and time-consuming and they should not be seen as a solution for all of a company’s financial problems.

Any decision to proceed with a debt to equity swap should therefore involve a review of the potential benefits that may arise, which should exceed costs involved if it is to be a worthwhile exercise.

The removal of debt from a company’s balance sheet will improve its financial profile in terms of gearing and other important balance sheet ratios, thereby removing or minimising any competitive disadvantage and providing scope for the company to attract new business and secure continuing credit from suppliers.