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Types of debt restructuring
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Features of debt restructuring agreements
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Benefits of debt restructuring
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Challenges of debt restructuring
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Best practices for debt restructuring
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Here’s what else to consider
Debt restructuring is a process of modifying the terms and conditions of existing debt obligations to achieve some financial relief for the debtor. It can be a voluntary agreement between the creditor and the debtor or a result of a legal proceeding, such as bankruptcy or insolvency. In this article, you will explore some of the common types and features of debt restructuring agreements and how they can affect the parties involved.
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- Dr. Chris Donegan Sceptical Empiricist.
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1 Types of debt restructuring
There are two main types of debt restructuring: debt rescheduling and debt forgiveness. Debt rescheduling involves changing the payment schedule, interest rate, maturity date or currency of the debt without reducing the principal amount. Debt forgiveness involves reducing or canceling part or all of the principal amount, usually in exchange for some concessions from the debtor, such as equity, assets or policy reforms.
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We all understand the structural elements however restructuring is at the margin, value recapture. The human/corporate relationships that comprise the transaction(s) should not be overlooked. Each party has different objectives which begin with but not end in principal recapture.
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- Dr. Chris Donegan Sceptical Empiricist.
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The financial position and motivation of the parties matters. eg: if the lender has already marked down their position its much easier. Many lenders are not able to hold equity, so debt-for-equity swaps are non starters, but future profit participation or revenue share may be. Rescheduling may be viable but a write off/bullet payment in conjunction with a refinancing may be preferred particularly if the lender is trying to wind up a prior fund and your loan is in it. In a prepackaged buyout too much debt kills the deal so combining an equity recap with a debt write down buys runway for repayment. Avoid PIK Notes.
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- Joe Hall Founder at Origins Commerical Finance
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When considering debt restructuring, it is essential to understand the difference between Debt restructuring and debt forgiveness. The two distinct approaches to managing debt obligations uniquely differ in application and implication. Debt restructuring aims to modify the terms of existing debt agreements to make them more manageable for the debtor. This can involve negotiating with creditors to lower interest rates, extend repayment periods, or alter the currency denomination of the debt. The goal is to alleviate the debt burden without reducing the amount owed.Debt forgiveness, however, directly reduces or eliminates a portion of the debt amount. This typically occurs when the debtor faces severe financial distress and cannot repay.
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2 Features of debt restructuring agreements
Debt restructuring agreements can vary depending on the type and amount of debt, the financial situation of the debtor and the creditor and the negotiation process. However, some common features of debt restructuring agreements are trade-offs between the creditor's and the debtor's interests, such as lower interest rates versus longer repayment periods. It often requires consent from all or a majority of creditors, especially if the debt is syndicated or securitized, to avoid holdout problems or litigation risks. Moreover, clauses that protect the creditor's rights and interests, such as pari passu, negative pledge, cross-default or acceleration clauses may be included. These clauses prevent the debtor from favoring other creditors, encumbering its assets, defaulting on other obligations or delaying payments. Additionally, there may be clauses that incentivize the debtor to comply with the agreement, such as grace periods, waivers, covenants or contingencies which allow some flexibility, forgiveness or conditions for debt restructuring.
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3 Benefits of debt restructuring
Debt restructuring can bring several advantages to both the debtor and the creditor, such as improving the debtor's liquidity, solvency and cash flow by reducing their debt burden and easing their repayment terms. It can also help avoid or minimize the costs and consequences of default, bankruptcy or insolvency, like legal fees, reputational damage, asset liquidation or loss of control. Furthermore, it can preserve or enhance the creditor's recovery rate by avoiding a complete write-off or a protracted legal process and by maintaining or improving the debtor's creditworthiness and profitability. Finally, debt restructuring can foster a cooperative and constructive relationship between the debtor and the creditor by demonstrating goodwill, flexibility and mutual respect.
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- Joe Hall Founder at Origins Commerical Finance
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Debt restructure can offer several benefits to both debtors and creditors. For debtors, debt restructure can:Reduce payments: By lowering interest rates, extend repayment periods, and consolidate multiple debts into a single loan, debt restructure can make debt payments more manageable and reduce the overall financial burden.Improve cash flow: By freeing up more cash, debtors can invest in growth opportunities to improve their financial standing while avoiding a risk of default.Prevent bankruptcy or liquidation: Debt restructure can provide a lifeline for struggling businesses, helping them avoid negative consequences of bankruptcy/liquidation.Protect assets: debt restructuring can help debtors protect their assets from seizure etc..
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4 Challenges of debt restructuring
Debt restructuring can be a complex and time-consuming process, involving multiple parties, interests and issues. It can also entail some costs and risks for the creditor, such as lower interest income, higher administrative expenses or exposure to currency fluctuations. Furthermore, debt restructuring can have some negative impacts on the debtor. Some of these negative impacts include lower credit rating, higher borrowing costs or dilution of ownership. Lastly, it can create moral hazard or adverse selection problems by encouraging the debtor to overborrow or underperform, or by attracting opportunistic creditors.
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- Joe Hall Founder at Origins Commerical Finance
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Debt restructuring is a complex process that can present challenges for both debtors and creditors.Complexity and Time Commitment: Debt restructure negotiations can be intricate and time-consuming, requiring expertise in financial analysis, legal matters, and negotiation strategies. The involvement of multiple parties, such as creditors, debtors, and government agencies, can complicate the process.Reputation: Debt restructure can negatively impact the debtor's creditworthiness, making it more difficult to obtain financing. Creditors may also face reputational risks if they are seen as accepting unfavorable terms or concessions that could set a precedent for other debtors.This represents a couple of challenges of debt restructure.
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5 Best practices for debt restructuring
To achieve a successful and sustainable debt restructuring, both the debtor and the creditor should communicate openly and honestly and act in good faith to build trust and understanding. It is also essential to seek professional advice from experts, such as lawyers, accountants or consultants. This will ensure compliance with legal and regulatory requirements, as well as evaluate the feasibility and implications of the debt restructuring options. Moreover, it is important to monitor and review the implementation of the agreement to make adjustments or amendments as needed.
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Firstly, if you’re going to propose any form of debt restructuring, it has to be on the basis that there is a profitable model going forward and such model needs to stand up to scrutiny, specifically its underlying assumptions.Secondly, why and over what period has the issue(s) leading to the requiring of the proposal occurred?Are the Board culpable?If so, then it can be a big ask expecting creditors/stakeholders to support the person(s) responsible without perhaps change or an additional Board appointment, such as an interim, in order to provide added confidence/comfort.
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Generally speaking, I would advise to focus on the following issues:- acting in good faith (contacting creditors way before any possible credit event, making them privy to more details about business plan)- review business plan and identify possible area of weakness- post mortem about existing situationShould creditors still believe in the viability of the business, there is plenty of room to negotiate: in fact, recovery value on a defaulted company's assets is usually pretty low, given the plethora of additional costs. Needless to say, it varies from industry to industry.
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6 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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Besides debt restructuring, it's important to look at other areas in the company for workflow improvements in all areas, with a look to reduce debt over time.
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