Understanding Debt Restructuring
Debt restructuring refers to avoiding the risk of default on existing debt or lower available interest rates. Individuals on the brink of insolvency also restructure their debt. Debt Restructuring is a process used by an individual or by a company facing cash flow problems & financial distress to avoid the risk of default to restore its liquidity so that it can continue its operations.
In simple words- Working out on old debt with a new debt refers to Restructuring.
Debt Restructuring In the times of Covid-19
As it is famously said “A crisis is a terrible thing to waste” those words resonate truer than today.
The covid-19 crisis is inflicting terrible human and economic costs, it may make it possible to address politically difficult changes in laws, policies, and institutions to save the environment we live in. The government should leverage corporate debt restructuring to support a robust, sustainable, and resilient recovery.
Debt Restructuring Process: How It works
Some companies seek to restructure their debt when financials are facing bankruptcy. A company might restructure several loans to subordinate in priority to other loans. Senior debt holders are paid before the lenders of subordinated debts if the company files for bankruptcy. Creditors are sometimes willing to reduce debt terms to avoid potential bankruptcy.
Debt restructuring sounds appealing, it’s not for everyone. It’s important to understand how it works and what are its advantages and disadvantages.
Methods to achieve debt restructuring
Any individual or a company can achieve debt restructuring by entering into direct negotiations with creditors or reorganize the terms of their repayment. Lenders and borrowers that can reach an agreement on a restructuring plan can. Different interested parties often commission their valuations and this can lead to conflicting ideas of how best to restructure the debt and borrower’s business. It can save time and be more productive for all parties to agree on a common valuation approach.
Debt restructuring typically involves the following approaches :
- Debt rescheduling– The aim is usually to give breathing space to a debtor in difficult times by extending the period of repayment and reducing the amount of each installment and by granting a period of grace during which no repayments will be made.
- Recapitalization– The term capitalization refers to a company changing the proportions of its debt and equity or the makeup of its share capital structure. This will be an attraction to a distressed borrower seeking to make its outstanding debt burden more manageable, it reflects the risk levels attached to different types of equity.
- Debt for equity swap– In debt for equity swap financial creditors receives shares in the restructured borrower in return for reducing or cancelling their debt claims. The debt for equity swap reduces the borrower’s balance sheet liabilities and potentially allows a lender to take some of the upsides, as a result of the swap the pre-existing equity holders will be diluted.
- Informal debt repayment agreements– companies that are restructuring debt can ask for lenient repayment terms and even ask to be allowed to write off some portions of their debts. This can be achieved by reaching out to creditors directly and negotiating new terms of repayment. This is a more affordable approach than involving a third party mediator and can be achieved if both parties involved are keen to reach a feasible agreement.
- Sale of Non-Core Assets– A borrower may be able to take the edge off by selling non-core assets or part of the business and using the proceeds to pay down its debts. A secured lender will need to give its consent to any breakup plan and be comfortable that the amount realized from the sale is appropriate and the remainder of the business will generate sufficient profits to repay its debts.
Get Your Free Implementation Plan!
Advantages and Drawbacks of Debt Restructuring
Concerning which direction you take with restructuring. By Entering into a debt restructuring plan or declaring bankruptcy there are some advantages and drawbacks you should be aware of it.
- Collection calls stop- Once you start restructuring your debts, you will be saved from continuous collection calls from lenders.
- Damage to your credit score ends- under a debt management plan, damage to your credit score stops happening. You are listed as current on your payments.
- Ability to pay off the debt in three to five years- This will give you peace of mind, with each approach you have a date for when you will pay off your debt.
- Long-term damage to credit report- If you declare bankruptcy it will damage your credit report, it will stay on your credit report for up to 10 years.
- Loss of access to cards- Going forward you will have to rely on cash until your credit improves enough that you can qualify for the new card.
- High Fees- If you work with a non-profit credit counseling agency for debt restructuring fees are minimal, but if you are bankrupt you will have to pay a huge amount.
Is debt restructuring the right choice?
Debt restructuring should be entered into unless there is a significant financial hardship, If you can manage your payments restructuring is not necessary. Though restructuring sounds like a lifeline when you are sinking into debt, it is not a magical solution. Debt restructuring should only be pursued when you are exhausted and you are left with no other option.
Debt restructuring depends on many factors, like the debtors’ financial management, the projected cash inflow, and the relationship between the debtor and the creditor. It is meant to help both parties. It involves compromises made by the creditor as well as the debtor to ensure that the loan is repaid in full to the creditor without too much of a financial loss to the debtor.
No matter what the circumstances in life, change is inevitable. How you handle change determines whether or not it results in success or failure and the only way to safeguard your business or yourself during a restructure is by taking a risk-based approach.