Corporate Debt Restructuring 101
What is debt restructuring?
Debt restructuring is a process in which a company renegotiates the terms on its loans to make them easier to pay back. It’s a common type of corporate restructure.
How to restructure your business debt: approaches & methods
Approximately 70% of small businesses have outstanding debt. Businesses can choose to refinance, consolidate, or restructure their loans.
Refinancing involves switching your loans to other loans with better interest rates or a longer loan term—whatever makes the repayments more achievable.
Consolidation involves taking out a single loan with achievable repayment terms that enables the borrower to pay back their other outstanding business debts.
Restructure involves negotiating with creditors to reach a mutually satisfactory plan of action that enables the company to remain in business while continuing to pay off their loans. This can be done either informally or formally (with the help of the court).
In reality, a business experiencing financial distress may do a combination of all of the above.
For instance, companies may begin by refinancing existing debt to lower their interest rates and lengthen the loan term. They may consolidate some debts and/or switch to interest-only for a while. They could also propose a restructure plan to certain creditors that includes a debt for equity swap.
Reorganizing your business debt does not mean you’ve failed. It’s a smart move that could save your company. The first step is to reach out to creditors directly to discuss the situation.
How does corporate debt restructuring work?
Out-of-court debt restructuring
It’s possible for a company and its creditors to renegotiate loan repayment terms without going to court.
Most lenders will be amenable to a company’s request to restructure its debt because the lender’s goal is simply to be repaid—not to put the company out of business. It’s just a matter of coming up with a mutually acceptable plan for the loan to be repaid according to slightly different terms (usually, over a longer period).
An out-of-court restructure is generally preferable to formal bankruptcy proceedings because it’s much less expensive. When a financially distressed company and its creditors can reach an agreement out of court, it’s the best result for everyone.
The earlier a business can recognize the realities of a poor financial situation and take the necessary steps to reorganize its debt, the more receptive creditors will be likely to negotiate. Leaving it to the last minute almost always results in court.
Debt restructuring legal proceedings
The legal proceeding for debt restructure is known as a chapter 11 bankruptcy.
A chapter 11 petition can be filed by the debtor or the creditor. Generally speaking, the debtor must provide to the court:
- schedules of assets and liabilities;
- a schedule of current income and expenditures;
- a schedule of executory contracts and unexpired leases; and
- a statement of financial affairs.
The following types of businesses can be reorganized via chapter 11 proceedings:
- Corporations (personal assets of the stockholders are not at risk—other than the value of their investment in the company's stock)
- Sole proprietorships (includes both the business and personal assets of the owners-debtors)
- Partnerships (the partners' personal assets can sometimes be used to pay creditors)
It should be noted that small business debtors can file for relief under two different special categories of chapter 11.
Debt restructuring pros and cons
Pros
- Lower interest rates
- Longer loan term
- Keeps your business afloat
- Possibility of debt consolidation
- Protects business assets
Cons
- Negative impact to credit score
- May incur expensive legal costs
- The business remains in debt for longer
Only you can assess and decide whether debt reorganization is the right move for your business. Take professional advice where possible and, if you’re going to act, it’s best to act early.
3 specific types of debt restructuring
1. Informal repayment agreement
This is an agreement between the creditor and debtor whereby payment terms are renegotiated without having to go to court. This is the most common form of debt restructuring and is described above in How to Restructure your Business Debt.
2. Debt-for-equity swap
This type of debt restructure is exactly what it sounds like. Creditors may agree to wipe the debt in exchange for an equity stake in the company.
3. Bondholder haircuts
This is actually a type of debt-for-equity swap, where a company that owes its bondholders x amount can reduce that debt by y, creating an equal amount of equity in the process.
The bottom line is that, if you’re in a tight spot financially, the sooner you do something about it, the better. Make sure you’re prepared with all the necessary financial details and work with your lenders to come to a mutually beneficial arrangement.