How to Restructure Distressed Debt

Distressed debt restructuring is often done to avoid bankruptcy.

Restructuring distressed debt is a complex task, involving difficult negotiations among many parties, as well as substantial financial expertise. To effectively restructure debt, a company must offer all of its creditors a compelling choice: either to accept the restructuring plan as presented or to lose money. Restructuring tends to involve all creditors either sacrificing seniority or giving up some upside. Fortunately, a smart debt restructuring can raise value for all stakeholders and ensure the future success of the company.

Things You'll Need

• Lawyers
• Investment advisers

Instructions

Avoiding Bankruptcy

1. Determine the value of the company as a going concern, and the value of parts of the company that can be sold. Find out how much liquidity the company has left (how much cash, cash equivalents, and credit lines), and how fast this is being used. These establish the parameters of a restructuring plan: the total value of the firm, and the amount of time left to restructure.

2. Determine the approximate interests of the different creditors. Some creditors expect to buy and hold indefinitely, with no price appreciation. Other creditors are involved in the company in order to make money and want their stakes to rise in value. Others become creditors in the course of business (for example, suppliers who have not yet been paid). In general, a restructuring plan should try to leave course-of-business creditors intact, give smaller amounts of debt to long-term holders, and give short-term holders equity instead of debt.

3. Create a plan that offers each class of creditors a new package of securities, and tell them what these will be worth. Each plan should be contingent on approval from a majority of the creditors. For example, a company in distress might agree to the following terms: suppliers will get paid, but with a 30-day delay; senior bondholders will get new senior debt plus junior debt, with a total market value of just below what they had before; and junior bondholders will get preferred stock and common stock with a value close to what they had before. This leaves the original common shareholders with much lower ownership of the company, but does avoid a costly bankruptcy.

4. Find parts of the firm that can be liquidated or borrowed against. This is a good way to get extra liquidity immediately before or after a restructuring. This process can include selling receivables, mortgaging or selling a company headquarters, spinning off subsidiaries, or simply cutting costs. While this can be done in order to avert a restructuring, it's also possible to do this after restructuring distressed debt: by delaying these cash-generating measures, a company can get a better deal from bondholders.

5. Once a deal is accepted, the company should determine its long-term capital structure goals. Most companies in distress have a different level or mix of debt than they would like to end up with, and it's good to create a path from that point to the ideal. This generally involves looking at future cash flow needs and opportunities, and creating a plan that diverts cash flow into paying back the least helpful kinds of debt.

Tips & Warnings

• Negotiating a bit with bondholders can be helpful.

• Equity holders have no rights in this kind of restructuring, but high equity prices are a useful asset.

• Giving special deals to individual bondholders is not always legal.

• Giving too much leeway to one set of creditors will set a bad precedent.

• If suppliers and partners feel cheated in a restructuring, it will harm the company's long-term value.

References

• Distressed Debt Investing
• Kellogg Northwestern: Introduction to troubled-debt restructuring
• Investopedia; Restructuring