Restructuring Investment Banking: The “Ins” and “Outs” of Advising Distressed Companies

What is Restructuring?

Restructuring is a process where a company under financial distress and experiencing liquidity problems restructures its existing debt obligations in order to gain more flexibility in the short term and make its debt load more manageable overall.

Restructurings either happen in court or out of court. An in-court restructuring typically happens when a company files for bankruptcy protection. Many jurisdictions recognize different types of bankruptcy, usually involving either a liquidation or a reorganization (for example, Chapter 7 vs Chapter 11 bankruptcies in the United States). The reorganization-style bankruptcy is also known as a restructuring.

As part of either an in-court or out-of-court restructuring, parties will typically hire qualified financial advisors to help navigate the complexities. Advisors may include lawyers, accountants, turnaround consulting firms, and investment banks that specialize in restructuring.

Causes of Financial Distress

Distressed companies are companies that suffer from a lack of liquidity and/or the inability to service its debt or other obligations. Distressed companies are also unlikely to be able to refinance debt, and may have already experienced a technical default by breaking a debt covenant.

Financial distress can be caused by several factors, including:

• A significant decline in business operations negatively impacting revenues, costs, income, and cash flows. This decline in operations may be due to external factors (for example, COVID-19 or a new competitor taking market share) or by internal factors like poor business judgment (for example, investing in poorly performing assets).
• Taking on too many debt obligations, resulting in the inability to repay creditors.

From a financial perspective, a company’s debt will trade significantly below par value. Alternatively, a company is thought to have distressed debt if the yield to maturity is trading 1,000 basis points (10%) over the comparable risk-free rate.

When companies experience distress, they have a couple of options: do nothing and hope the business recovers, proactively enact various strategic actions to improve performance, or restructure their obligations. A restructuring investment banking group is brought in to help with the latter option and is the focus of this guide on restructuring investment banking.

When Does Restructuring Typically Take Place?

Outside of things like pandemics, financial distress does not typically happen overnight; rather it’s a long, drawn-out development impacting companies that have made poor business decisions.

For example, companies may have made poor investment choices, like inadvertently entering into unprofitable business lines. Other times a company may become distressed if it fails to understand changing market dynamics. A classic example of this is the failure of Blockbuster Video due to the innovation of Netflix.

As mentioned earlier, once a company realizes it is in distress it has several options. Whether the company undergoes an in-court or out-of-court restructuring, it will hire advisors to assist with its choices. A debt restructuring will usually take place just prior to an imminent interest payment or upcoming maturity. The company, and its advisors, will need a plan of action if the company is unable to meet these obligations.

Role of the Restructuring Investment Bank

A restructuring investment bank is one of the advisors brought on as part of any restructuring. For any restructuring, there are two sides: 1) the debtor side and 2) the creditor side. Restructuring investment banks will work with either the debtor or the creditor(s) but not both at the same time (due to potential conflicts of interest).

Essentially, restructuring is ultimately a compromise between the debtor and creditors. The compromise allows the debtor to continue operating, this time with an improved capital structure, and ensures creditors are reasonably happy with their expected returns.

Advising Debtors

When advising debtors, restructuring investment banks will review and analyze the debtor’s specific situation, advise the company on its options, and help it chart the correct path.

Before filing, the debtor is advised to draw as much as possible on any revolving credit facility it may have. The rationale being that a company will need to do everything possible to preserve liquidity (access to the credit facility would be frozen upon the bankruptcy filing) and fully drawing on the revolver will increase cash and give the debtor a little bit more leverage when dealing with this creditor.

As part of advising the debtor, restructuring bankers may recommend selling certain assets to raise funds (if these sales are allowed under existing credit agreements). As part of the asset sale process, bankers may run an auction and enlist the help of a stalking-horse bidder. In some jurisdictions, these asset sales are considered “free and clear” of any obligations of the selling debtor. The investment bank may be able to generate additional fees as part of this sales process.

If the bank obtains a mandate to advise a debtor, a common misconception of restructuring investment banking means the bank is advising a company that is going out of business. While some companies will be unable to restructure and will instead liquidate, restructuring begins with the assumption that the debtor will continue operating the business while working to reduce a burdensome debt load. Additionally, creditors generally will also want the company to succeed as this usually increases the recovery rate the creditors may receive.

Advising Creditors

Speaking in generalities, the restructuring banker’s workload is lighter when advising creditors. This is due to the inherent nature of the parties: creditors simply want to maximize their recovery rates and will almost always be highly sophisticated investors that understand the restructuring process.

Because of this, creditors will likely have already been through various restructurings and they really only have to evaluate the proposed plan of reorganization and decide how to vote. Unlike debtors, creditors do not have to prepare the significant amount of restructuring materials (disclosure statement, plan of reorganization, monthly operating reports, 13-week cash flow models).

As a restructuring investment banker advising a creditor, the sole objective is to help the creditor realize the greatest possible recovery. Therefore, restructuring investment bankers will perform due diligence on the debtor and attempt to poke holes in the plan of reorganization. If there are any issues, this could strengthen a creditor’s position and generate a higher recovery.

Another advantage to restructuring banks who target creditor-side mandates: there are usually multiple classes of creditors (from secured creditors to unsecured creditors and potentially more). This means there are multiple opportunities to land a mandate advising a class of creditors when compared to advising the debtor, which typically only hires one restructuring investment bank.

Finally, creditors (especially bondholders) may hire an investment bank so this class of creditors can avoid material, non-public information and remain unrestricted in terms of their ability to trade the bonds. If there is an acceptable reorganization plan, then the creditor’s investment bankers can then communicate this to the creditors, at which point the bondholders are no longer allowed to trade on the information (until the plan is made public).

Out-of-Court Restructuring

An out-of-court 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.

Potential solutions in an out-of-court restructuring may include the following:

• Debt Modification: A debtor can ask creditors to change their terms, for example by changing an interest rate or maturity date (an “amend and extend” strategy). However, creditors are typically reluctant to do so without some other enticement that improves the creditors’ position. An example of this might be that the company will ask for a later maturity date but will grant the creditor a lien on certain assets.
• Debt Exchange: Creditors may agree to forgo a certain amount of outstanding debt in exchange for equity or a new debt instrument (or even a different security like preferred stock). 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. However, if equity is issued to creditors, this means significant dilution to company shareholders. Additionally, a debt exchange can lead to a “holdout” problem. A holdout problem is created because no creditor can ever be forced to give up its rights to payment outside of a legal process like a bankruptcy filing.
• Voluntary Haircut: A debtor may ask a creditor to take a haircut on the amount the debtor owes. In this context, a creditor would voluntarily reduce the amount it’s owed from the debtor. However, similar to a modification, this is unlikely to happen unless there is some other concession made by the debtor or the creditor thinks the haircut would still be better than an expensive, in-court restructuring.
• Debt Repurchases: It’s also possible for a debtor to repurchase some of its debt from creditors. This may occur if the company has some excess cash to use and the debt is trading at distressed levels. Repurchasing debt will effectively reduce the go-forward interest expense of the debtor but there’s no guarantee a creditor would sell.

Unfortunately, while less time-consuming and cheaper compared to in-court restructurings, out-of-court restructurings are hard to effect since it’s impossible for debtors to unilaterally change credit terms outside of a formal, legal process. Because of these creditor rights, even out-of-court restructurings will typically follow the rules of an in-court proceeding.

In-Court Restructuring

If a company cannot restructure out of court, it may have to result to an in-court restructuring. This will usually require the debtor to file for bankruptcy protection (a Chapter 11 filing in the United States).

In-court restructurings are inherently more expensive and time-consuming when compared to out of court. In fact, in-court restructurings can take many months (potentially years!).

As in an out-of-court process, an in-court restructuring usually requires multiple advisors for both the debtor and creditor. Additionally, there are statutory timeframes that must be adhered to as part of an in-court filing.

For example, under a voluntary Chapter 11 filing, the bankruptcy court requires the debtor to propose a plan of reorganization within 120 days from the date of filing the bankruptcy petition. If the debtor meets this target, the court grants another 180 days to allow the debtor to obtain confirmation of the plan from creditors and other interested parties.

In an effort to reduce the time and cost of an in-court process, many debtors elect to try a prepackaged bankruptcy — colloquially known as a “prepack.” In a prepack, a distressed company negotiates with creditors, receiving their support before the debtor actually files for bankruptcy.

During an in-court restructuring, the company is referred to as the debtor in possession (DIP). The bankruptcy petition may be voluntary or involuntary. A voluntary petition is submitted by the debtor, while an involuntary petition is filed by creditors.

How Does a Restructuring Investment Bank Get Paid?

People might wonder why an investment bank would advise a distressed company. Isn’t there a risk of not being paid? Yes, in theory, there’s always a risk. Having said that, at least in the context of an in-court restructuring, advisors to the debtor are basically first in line to be paid (they are granted a “super-priority” administrative status). Therefore, debtor-side advisors are almost always assured of being paid.

Regardless of whether a bank is advising a debtor or a creditor, the bank will usually receive a monthly retainer. If the company successfully restructures, both the debtor’s investment bank and the creditor’s investment bank will each receive a success fee, but the debtor’s fee is usually much larger.

Additionally, the debtor’s restructuring bank may generate additional fees for asset sales and capital raises like DIP financing. As part of the plan of reorganization, the debtor may be required to pay any creditor’s advisory fees.

While a creditor mandate is usually less lucrative compared to working with a debtor since there are more opportunities to advise creditors, restructuring investment banks can make up the difference in fees.

Key Technical Skills for Restructuring Investment Bankers

As in any investment banking role, a restructuring investment banker will still need strong technical modeling skills, quickly update PowerPoint, and the ability to perform industry analysis and monitor companies for potential restructuring (by calculating credit ratios and yields).

Restructuring professionals must also develop a strong knowledge of restructuring dynamics, whether it is an in-court or out-of-court restructuring. For example, investment bankers must understand the absolute priority rule to appreciate the competing priorities between the debtor and creditors (and even between different creditor classes themselves!).

Absolute Priority Rule

The absolute priority rule states that junior classes of creditors (and equity holders) cannot receive debtor property, unless all senior classes are either paid in full first or vote to accept the reorganization plan.

For example, secured creditors would be paid back first, followed by unsecured creditors, and then assuming there are still proceeds or other consideration, equity owners may receive debtor property (cash or equity).

This directly impacts recovery rates. Let’s look at a simple example:

• The debtor generates $20 million in EBITDA, and bankers think the debtor’s enterprise value is 4x EBITDA.
• The debtor has $50 million in secured debt and $100 million in unsecured debt.

We start by calculating the projected enterprise value of $80 million (4 * $20 million in EBITDA). With secured debt of $50 million, the secured debtholders can expect a 100% recovery rate, leaving $30 million of value ($80 million enterprise value minus $50 million of secured debt).

This leaves unsecured debtholders with a projected recovery rate of 30% ($30 million of remaining value divided by $100 million in unsecured debt). Since unsecured debtholders have a less than 100% recovery rate, equity holders should expect a 0% recovery rate (equity holders are almost always wiped out in an in-court restructuring).

While there are occasional derivations from the absolute priority rule (see the “super-priority” administrative status mentioned earlier), this rule will broadly inform both in-court and out-of-court restructurings.

Fulcrum Security

Another concept that restructuring professionals should understand is that of the fulcrum security. The fulcrum security is the highest impaired security (under the absolute priority rule) that will likely receive equity if the reorganization is successful.

Using our above example, the fulcrum security is the unsecured debt, since this is the most senior impaired security in the simple capital stack. The unsecured debtholders would likely receive the overwhelming bulk of equity in the restructured company.

The holders of the fulcrum security will usually be the most important class in a plan of reorganization, and fulcrum securities are targeted by distressed debt investors because of that. The fulcrum security has the most negotiating leverage in a restructuring, as well as the most to gain in a successful restructuring.

Valuation of Distressed Companies

When considering the valuation of distressed companies, or companies in restructuring, the analysis is almost always focused on enterprise value, not equity value… since the go-forward equity value will be relatively small initially.

While both intrinsic and relative valuation methodologies still apply, an analyst must consider the impact of the restructuring impacting things like EBITDA and free cash flow. For example, suppliers may require cash on demand since suppliers will naturally be concerned with the debtor’s ability to pay its bills.

A potential quirk when trying to value a company during an in-court restructuring is that restructuring investment bankers will usually need to prepare a Liquidation Analysis. The Liquidation Analysis is almost always going to be lower than the going-concern valuation. However, this analysis is necessary because it might be the rare case that a liquidation will result in higher recovery rates. In this case, a bankruptcy court may convert from a reorganization to a liquidation (in the United States, from Chapter 11 to Chapter 7).

Other Required Skills for a Restructuring Investment Banker

As discussed earlier, restructuring investment banking can be one of the most technically challenging roles in investment banking as professionals need to have a deep understanding of finance, accounting, and ideally, bankruptcy law.

In particular, restructuring bankers need to have a thorough understanding of capital structure, and be able to problem-solve a distressed company’s needs, coming up with potentially creative solutions to “right-size” a debtor’s balance sheet. For example, restructuring professionals need to understand the specific seniority of different instruments and the relative trade-offs when restructuring debt, whether it’s an out-of-court or an in-court restructuring.

Although restructuring investment bankers don’t have to be lawyers, it helps to be able to read, understand, and interpret complex legal documents.

Restructuring Investment Banking vs Traditional Investment Banking

Overall, restructuring investment banking is similar to traditional investment banking in that it has the same strict hierarchy. Analyst is usually the entry level, followed by associate, then vice president, with managing director usually being at or near the highest level.

Additionally, both have long hours. Traditional investment banking analysts will work 70 to 80 hours each week (or more, depending on the deal pipeline). Restructuring investment banking analysts may even have longer hours due to tight restructuring-focused deadlines and the fact that staff levels are lower in restructuring.

Competition for Restructuring Roles is Even More Fierce

Restructuring investment banking is becoming more popular, but it’s usually a little harder to get into compared to regular investment banking. This is because restructuring groups don’t hire as many analysts or associates compared to investment banking groups. Additionally, the pay in restructuring investment banking is typically higher than in investment banking, increasing the level of competition for positions.

Furthermore, restructuring investment banking is at a relatively unique nexus of finance, accounting, tax, and law that many professionals or candidates find intriguing. Having said that, it means professionals might have to review long credit agreements or bond indentures, interpreting the technical legal language into a potential plan of action.

This nexus means each individual transaction is relatively unique, which minimizes the occasional repetitive nature of many tasks in traditional investment banking. Restructuring bankers must therefore craft specific, bespoke solutions for their clients, especially if they are involved in a debtor-side mandate.

Additionally, most restructuring investment banks are elite boutique or middle-market investment banks versus the larger, “bulge-bracket” investment banks. Larger investment banks don’t usually “play” much in restructuring since they already likely have an existing relationship with the distressed company or the distressed company’s creditors, presenting a potential conflict of interest (for example, the investment bank may have arranged the distressed company’s most recent bond offering).

Pros and Cons of Restructuring Investment Banking

Some of the reasons why restructuring is a popular choice is because of the following:

• Diverse Opportunities: No restructuring is the same, so professionals need to be able to come up with bespoke solutions depending on highly specific circumstances. This requires bankers to have a large and diverse skillset, with strong critical thinking capabilities.
• Industry Agnostic: Although some industries have a tendency to restructure more frequently than others (cyclical industries), restructuring professionals will usually be exposed to many different industries and business models. This makes restructuring more challenging but potentially more intellectually stimulating.
• Counter-cyclical: Restructuring activity is effectively counter-cyclical, meaning its relatively better in an economic downturn compared to mergers and acquisitions and capital markets banking.
• Greater Pay: Pay is typically higher than comparable pay at a bulge-bracket bank since elite boutique banks tend to pay higher bonuses.

However, there are some drawbacks:

• Even Longer Hours: Since boutique investment banks do the bulk of restructuring work, there are usually fewer members to a team and thus a heavier workload for the current team. Additionally, regardless of an in-court or out-of-court restructuring, there are always tight deadlines for a deal to take place.
• Less Diverse Exit Opportunities: One of the benefits of traditional investment banking is the fact that there are so many different exit opportunities. While exit opportunities are still good in restructuring, they just aren’t as diverse. For example, corporate development isn’t a typical exit since healthy corporations don’t need restructuring professionals and distressed companies aren’t increasing their hiring.

Restructuring Investment Banking Exit Opportunities

Having said that, restructuring is a highly technical role so this will help in exit opportunities. Restructuring professionals joining a credit fund or a distressed debt fund is common. Private equity is also a common exit.

Top Restructuring Investment Banks

As discussed earlier, bulge bracket investment banks don’t usually target restructuring opportunities, and most restructuring banking is done by elite boutique banks. Some of the top restructuring investment banks include the following (among others):

• Houlihan Lokey
• PJT Partners
• Lazard
• Evercore
• Ducera
• Moelis
• Jefferies

Related Readings

CFI offers the  Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

Restructuring Advisory

Chapter 7 Bankruptcy vs Chapter 11 Bankruptcy

Debt Restructuring

Asset-based Lending

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