Having debts isn’t necessarily good or bad. Many consider it a convenient business tool at their disposal. Getting a loan has its benefits, such as increasing cash flow and ensuring business continuity or becoming a lifeline that keeps the business afloat. However, when unexpected events throw a wrench at your carefully planned payment scheme, it can become harder for your business to meet its payment obligations.
When debt becomes unmanageable, debt restructuring or business restructure loans presents a way out. It might include asking a lender for a temporary reduction of the loan’s interest rate or requesting a payment date adjustment from a vendor. Either way, debt restructuring entails the modification of the terms of existing debts to the mutual satisfaction of you and your creditors so that the debts become more manageable and easier for you to pay. It’s essentially a renegotiation of the terms to ensure you avoid defaulting on your payment obligations.
A business restructure loan (or debt restructuring) isn’t a new loan, but a process of renegotiating terms of existing debt with lenders to make payments more manageable, often as a last resort before default or bankruptcy. Reputable companies can be an invaluable resource in this type of situation by funding quickly and with less restrictive covenants. Since the asset is the collateral, there is maximum liquidity and fewer rules. Line of credit grows with asset growth. This flexible solution effectively bridges the gap in business transactions, accelerating the sales cycle.
Thanks to these modifications, debt restructuring eases some of the financial pressure you might be feeling, restores cash flow, and ultimately enables you to regain control over the finances of your business. So, it’s not a sign of failure but rather a strategic tool to improve liquidity and ensure long-term viability.
Taking on debt is a normal part of doing business. In fact, around 70% of small businesses have outstanding debts, according to a survey by the Federal Reserve.
Debt-for-Equity Swap
A type of debt restructuring that’s most common among businesses typically in severe financial distress, i.e., with high debt, but show strong growth potential is debt-for-equity swap or debt-to-equity conversion.
The modification of credit terms here deals with the cancellation of a portion or all of the business’ outstanding debts in exchange for a predetermined amount of stock or equity (ownership) in the business. In other words, creditors become shareholders (owners) of the business by exchanging outstanding debt for equity shares, swapping priority for repayment for priority for dividend payments or their share of the profits.
A debt-for-equity swap transaction is typically valued at current market rates, but the debtor may offer a higher exchange value to entice creditors to participate in the swap.
Because the lender is now an owner, the obligation to pay for that portion of the debt that was exchanged for equity is now eliminated. A debt-for-equity swap also helps a business reduce its debt burden, enhance cash flow, and avoid bankruptcy. However, because there are now more shareholders, the original owners’ control over the business is diluted and it can decrease the value of existing shares.
Debt Haircut (Principal Reduction)
A debt haircut refers to a debt restructuring agreement wherein a creditor forgives, i.e., deletes, eliminates or cancels, a portion of the principal balance owed by a business. For instance, if a business owes its creditor $500,000, the latter may accept to receive a discounted amount, say $350,000, as full payment.
Creditors often allow this setup when they believe that the alternative would be a worse outcome. That is, for them, it’s better to receive some money back than nothing at all if the business defaults or declares bankruptcy. However, they will typically only agree to a debt haircut after they have performed an exhaustive audit of your books, i.e., they are convinced that your business is truly in financial distress and can’t afford to pay the full amount.
From the business’ point of view, a debt haircut results in owing a smaller amount of money, thereby reducing their debt burden. That is, the loan becomes more manageable, thanks to the reduction, and they have a higher chance of actually being able to pay it off.
However, note that a debt haircut is considered to be taxable income. The IRS will be at your doors to collect cancellation of debt income as a result. Also note that a debt haircut will be reported to credit bureaus as “settled for less than full balance,” which will make it difficult for your business to secure new loans for several years.
Informal Debt Repayment Agreements
Often referred to as “workovers” or “voluntary arrangements,” these are private negotiations between a business and its creditors to change the terms of the loan without involving the court system. Businesses and their lenders often use these agreements to preserve their professional relationship and avoid lengthy and expensive formal legal proceedings.
Term Extension
Term extension refers to a type of debt restructuring that spreads payments over a longer period of time. Essentially, it allows you to extend the term, or payment period, on your loan.
For instance, an original debt agreement comes with a 5-year term, but with a term extension, this can be moved to 10 years. In other words, the original loan term is modified so that the business can spread out its repayment over a longer period.
A term extension not only gives you more time to pay back your loan, it also provides for a reduction in the amount of monthly payments you have to make, one that is more manageable for you so that you don’t fall behind on them. The downside, however, is that you might end up paying more for your loan in total than what was originally computed.
Getting a term extension depends on several factors, including your financial situation and the reason you need an extension.
It is a common practice when paying supplier invoices, especially among seasonal businesses and growth companies. Businesses working on cash flow optimization and improving their financial metrics for mergers and acquisitions or other purposes may also take advantage of a term extension.
Table 1. Benefits of Term Extension
| Benefits for Buyers | Benefits for Suppliers |
| Improved working capital Smarter cash flow management and better cash flow timing Increased financial flexibility Enhanced debt capacity Gain more control over growth Competitive advantages, e.g., fund innovation, marketing, or competitive responses | Strengthened buyer relationships Access to early payment options Volume security Preferred status Business growth support |
Interest Rate Reduction
In an interest rate reduction agreement, the creditor agrees to lower the percentage of interest charged on the outstanding principal loan amount. As a result, the monthly repayments become more affordable; it doesn’t cancel the debt as a debt haircut would do nor does it extend the loan term.
Payment Holidays (Deferment)
Similar to the holidays we go on to take a break from work and daily life, a payment holiday is a temporary freeze on your monthly loan repayments. You could look at it as a deferment of loan repayments for a set period of time.
It’s the best type of debt restructuring for businesses that are experiencing a temporary cash flow gap, for instance, if you’re a new or seasonal business or one that’s experiencing a one-time disruption. Payment holidays enable the business to build up its cash reserves. It’s like hitting the pause button on your loan payments to stock up on cash before resuming payments.
Once the payment holiday is over, your creditor will usually require you to either extend the loan (term extension) or increase your monthly payments. This is to allow for accrued interest to be included when you resume payments.
0 Comments