What is Debt Restructuring?
Debt restructuring is the process wherein a company or an entity experiencing financial distress and liquidity problems can refinance its existing obligations in order to gain more flexibility in the short term.
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 more efficient and cost-effective in the long term than 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 debt payments. Alternatively, debt restructuring can also be imposed upon companies that fail to honor the terms of the agreement. Here are some ways that it can be achieved:
1. Debt for Equity Swap
Under such circumstances, the debtors would agree to forgo a certain amount of outstanding debt in exchange for equity in the company. It usually happens in the case of companies with a large asset and liabilities base, where forcing bankruptcy creates little value for the creditors.
It is deemed beneficial to let the company operate as a going concern and then allow the creditors to be involved in its operations. It can mean that the original shareholder base will now own a significantly diluted or even a diminished stake in the company.
2. Bondholder Haircuts
Companies with outstanding bonds can negotiate with its bondholders to offer repayment at a “discounted” agreement; it 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 write off some portions of debt. It can be done by reaching out to the creditors directly and negotiating the terms of repayment. It 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 the 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 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 herein are 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 repayments. On the other hand, debt refinancing is merely the replacement of an old debt with a newer debt, usually with slightly different terms.
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