In this prevailing economic climate, as companies look for ways to access cash, one method to relieve pressure and free up additional cash flow is to restructure the debt of your organization. This gives your company the flexibility it needs to keep operating, while allowing time to fix any underlying issues within the organization. For the lending institution, it allows the debt to stay current, classifies it as performing and avoids potential reserves.
A restructuring of debt can also, at times, help avoid bankruptcy, which is typically a last ditch effort to keep the company operating and possibly avoid debt repayment altogether. While many creditors may not agree to this type of arrangement immediately, some will come to understand that it may be beneficial for them to help ease the burden of the company rather than hasten a potential downfall by remaining firm in a position of collection or foreclosure.
What are the types of debt restructuring? It can take many forms from interest rate reductions for a period of time, to longer amortization schedules, to taking a principle holiday to lower overall payments. In addition, other debt—such as trade payables —can be restructured into a note or long-term payout many times with little or no interest.
In some cases, companies are able to get debt holders to write down the debt or write off a portion of the debt. This is typically done with trade debt. Institutional debt write-downs happen in rare occasions and usually occur when another party comes in to buy out the debt at a deep discount. Most institutions will not write down or write off part of the debt with the same debtor, although this can happen. It really depends upon the leverage a company might have in the negotiations, the collateral position and the condition of the lending institution.
The core issues being faced by the management team will determine the type of restructuring that may work. Short-term liquidity needs can often be addressed with a principle holiday, in which a company is not required to make principle payments for a period of time (typically three to six months and sometimes up to a year). Interest is still charged and due each payment period, but by eliminating a regular principle payment, a significant amount of cash can be freed up. For long-term needs, it may make sense to utilize lower interest rates and longer amortization schedules and also take a portion of the principle and put it on the back end with a balloon payment.
But before you reach out to your lenders for a debt restructuring plan, you should develop a business plan to show lenders that you have a handle on the issue and are in a position to move the company in a positive direction. This is not a hastily thrown together plan, but one based upon strategies that reflect current conditions and how management might take advantage of them. Most lenders will discount the revenue projections if they are significantly different than industry performance, unless the company has some truly disruptive technology or differentiator. What most lenders will want to see is a plan that has cost reductions to reflect the current revenue picture along with some revenue growth, which should be based upon new products, new customers and possibly even new markets.
What are the creditors’ and/or lenders’ objectives?
Creditors who often agree to negotiate the terms of the debt agreement focus on the following objectives:
- Support the objective of a struggling debtor company to financially recover
- Enable strong debtors to carry on as before with their business operations
- Agree to a feasible, equitable and fair debt repayment plan to creditors
- Secure the collateral position of the note to support repayment
- Look for a significant portion of revenues from operations to be set aside to support part of the payment to creditors
- Safeguard the money lent by financial institutions through additional collateral or in lending additional funds that will elevate the financial position of the company
Understanding the lenders’ objectives will help you position your case to meet those objectives while helping lenders meet their own.
Corporate debt restructuring should be completed one step at a time. The following are the steps that need to be taken with the lender before a final agreement on a restructured debt instrument can be signed.
Consultation between the lender and debtor—Business debt restructuring is essentially an aggregate loan agreement, which accumulates a number of discussions and agreements. To reach that point of an agreement, the lender will hold a series of sessions with the borrower. During these meetings, the lender assesses the company’s overall financial situation and evaluates management competency to be successful under a restructured business. It’s at this point that all the company’s financial obligations are evaluated against the expected regular cash flow. This is the period where the lender gains comfort that the debtor can repay the new restructured loan and will be able to correct any underlying business issues.
Negotiation begins—Once the assessment procedure is finished, the lender then negotiates a settlement agreement for the new note or forbearance with the debtor and possibly with other creditors and vendors of the debtor. All parties need to be accepting of the revised agreement—even the other creditors of the business.
Some liquidation of assets may be required—In some cases, restructuring existing debt may require a payment of money up front. Since you may be in a tight cash position, some assets may have to be liquidated in order to meet the upfront payment. Though, this is not typical as the lender will probably want as much collateral available as possible.
Restructuring begins—At this stage, the contract is signed and the agreement is enforced. The borrower, and in this case the business, agrees to the new or revised loan amount and to other details, including the monthly payment obligation, interest rate, collateral, personal guarantees and term of payment. After everything is accounted for, the business is officially under a debt restructuring program and is expected to make payments as stipulated.
The process may appear straightforward, but it can take several months to complete and take an emotional toll on both parties. It’s important to pace the process, try to keep emotions out of it and be prepared for some bumps along the way. Consider the support of a professional consultant who has experience helping businesses through this process. A consultant can help take emotions out of the equation, assist with preparation of the business plan and understand the needs of the banks on the other side of the table.
If you decide to engage in a debt restructuring process, you should keep these basics in mind:
- The process can take several months and multiple sessions. At times, it may appear that the negotiation process will break down and no agreement will be reached, but patience and the ability to take a step back at times to let emotions cool can help to finalize the deal.
- Personal guarantees, if not already in effect, will most likely be required unless the loans are over collateralized by a factor of two to three times.
- Don’t leap into the plan without careful consideration. Company debt restructuring is a process that must be critically evaluated to ensure the ultimate fate of the business involved.
- In many cases, this may well be the last level of debt help available to the business before filing for bankruptcy. Keeping this in mind will help both sides stay focused on the immediate goal.
This business tool can help give companies that have great products or services, strong markets and good leadership an opportunity to grow and succeed in the marketplace, keep staff employed and continue to serve their customers.