For a company in financial difficulty, but which ultimately remains a viable one, a debt-for-equity swap can be an effective way to restructure its capital and borrowing and, in so doing, strengthen its balance sheet and deal with such issues. that like a speeding ticket.
Debt for a share swap involves a creditor converting debt owed to it by a business into equity in that business. The effect of the swap is the issuance of equity to the creditor in settlement of the debt, so that the debt is discharged, discharged or extinguished.
For a creditor, a debt-for-equity swap can be a way to avoid the costs associated with starting the debt collection process (which may not be fully collectable in the current environment) and can provide a means by which a creditor can participate in any future growth of the business.
Debt against equity swaps can be used in many situations, including:
- restructure the debt with a large non-bank creditor;
- change the proportion of debt and equity held by shareholders to strengthen the company’s balance sheet; Where
- to create a strategic alliance with a major supplier.
Whatever the circumstances, debt-for-equity swaps provide an opportunity for a business to proactively deal with creditors before creditors take steps to collect debts and, in the case of secured creditors, to do so. assert its guarantee and / or appoint an external administrator.
Equity Swap Debt Trade Terms
The key terms to be determined are:
- the value of the business and whether shares should be issued at a price lower than that value;
- the amount of debt to be substituted for equity and the extent to which existing shareholders will be diluted;
- the type of participation that will be acquired (for example, ordinary shares, fixed / preferred dividend shares, shares, redeemable shares or convertible securities);
- the rights which will attach to the participation in the capital (for example, priority on the income and the capital, the right of veto on certain decisions of the company or the right to appoint directors); and
- the restrictions that will be imposed on participation (for example, restrictions on transfers or limits on voting rights).
Setting up a debt-for-equity swap
Carefully planned engagement with participating shareholders and creditors is crucial to successfully undertaking a debt-for-equity swap.
Contractual (i.e. non-statutory) debt for share swaps between the company and participating creditors can be simple and flexible. The company plays the lead role (along with its attorneys) in preparing and negotiating the documents necessary to effect the debt-for-stock swap, including debt forgiveness, stock issuance, and debt agreements. ‘shareholders.
In contrast, statutory debt-to-equity conversions can be complex, costly, and are typically administered by an insolvency practitioner, meaning the company and its officers have significantly less control over the business. process. An example of where a company may be able to implement a debt-for-stock swap using legal process is where the company executes a Company Understanding Agreement (DOCA) in accordance with the legal process defined in Part 5.3A of the Companies Act 2001. (Cth). However, a statutory procedure can be useful when the business is unable to negotiate with its creditors, as it will be binding on all creditors if they are accepted by the required majority and can therefore be used to ‘crush’ creditors. objectors or more junior.
Other points to consider when considering a debt-for-stock swap include:
- the consents and approvals required from shareholders;
- the tax and accounting treatment of debt against equity swap;
- all other questions to be dealt with in the context of the exchange of receivables for shares (creation of new shares, modifications of the articles of association or shareholders’ agreements and removal by the shareholders of their preferential subscription rights);
- (for listed companies) the rules of the stock exchange on which they are listed; and
- the takeover provisions under Chapter 6 of the Corporations Act 2001 (Cth).