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Debt restructuring is a process wherein a company or an entity experiencing financial distress and liquidity problems refinances its existing debt obligations in order to gain more flexibility in the short term and make their debt load more manageable overall.
Reason for Debt Restructuring
A company that is considering debt restructuring is likely experiencing financial difficulties that cannot be easily resolved. Under such circumstances, the company faces limited options – such as restructuring its debts or filing for bankruptcy. Restructuring existing debts is obviously preferable and more cost-effective in the long term, as opposed to filing for bankruptcy.
How to Achieve Debt Restructuring
Companies can achieve debt restructuring by entering into direct negotiations with creditors to reorganize the terms of their debt payments. Debt restructuring is sometimes imposed upon a company by its creditors if it cannot make its scheduled debt payments. Here are some ways that it can be achieved:
1. Debt for Equity Swap
Creditors may agree to forgo a certain amount of outstanding debt in exchange for equity in the company. This usually happens in the case of companies with a large base of assets and liabilities, where forcing the company into bankruptcy would create little value for the creditors.
It is deemed beneficial to let the company continue to operate as a going concern and allow the creditors to be involved in its operations. This can mean that the original shareholder base will have a significantly diluted or diminished stake in the company.
2. Bondholder Haircuts
Companies with outstanding bonds can negotiate with its bondholders to offer repayment at a “discounted” level. This can be achieved by reducing or omitting interest or principal payments.
3. Informal Debt Repayment Agreements
Companies that are restructuring debt can ask for lenient repayment terms and even ask to be allowed to write off some portions of their debt. This can be done by reaching out to the creditors directly and negotiating new terms of repayment. This is a more affordable method than involving a third-party mediator and can be achieved if both parties involved are keen to reach a feasible agreement.
Debt Restructuring vs. Bankruptcy
Debt restructuring usually involves direct negotiations between a company and its creditors. The restructuring can be initiated by the company or, in some cases, be enforced by its creditors.
On the other hand, bankruptcy is essentially a process through which a company that is facing financial difficulty is able to defer payments to creditors through a legally enforced pause. After declaring bankruptcy, the company in question will work with its creditors and the court to come up with a repayment plan.
In case the company is not able to honor the terms of the repayment plan, it must liquidate itself in order to repay its creditors. The repayment terms are then decided by the court.
Debt Restructuring vs. Debt Refinancing
Debt restructuring is distinct from debt refinancing. The former requires debt reduction and an extension to the repayment plan. On the other hand, debt refinancing is merely the replacement of an old debt with a newer debt, usually with slightly different terms, such as a lower interest rate.
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