Can your business manage its debt burden?

Has your business had to take on significant levels of debt in the last two years? Is that debt supportable? If your business is viable, proactively addressing your debt burden is key to your long-term survival.

This article looks at a range of options which may be available in situations where your debt is currently unsupportable. In practice it may be that one of these options is sufficient to solve your debt issues or you may need a blend of more than one option.

Although not the subject of this article, it is very useful to have built a financial model and make sure you have accurate cash flow forecasting so that you have a genuine understanding of whether your debt burden is supportable and your priorities for tackling it.

Equity recapitalisation

If your business is viable but over-geared, your first step may be to seek to raise additional equity. The process of recapitalisation can change the proportions of the debt and equity structure and so make the debt burden more manageable.

In practice, your existing shareholders may not want or be able to participate in recapitalisation and will face having their equity holding diluted. You may have to change the share structure and introduce new equity participants. This usually requires careful stakeholder management.

Sale of non-core assets

An option that you should consider early on, is the sale of non-core assets or parts of the business and using the proceeds to pay down debt. The consent of secured lenders will normally be required for any such transaction and you will need to demonstrate that the remaining business can generate sufficient cash to service the residual debt.

Debt restructuring

Where the above options are not available, or sufficient to fully recapitalise your business, a debt restructure may be a potential option. Lenders will typically consider a restructuring if your business is distressed and there is a high risk that it could enter an insolvency process.

Debt restructuring processes usually take time to negotiate, document and implement. As a result, temporary covenant waivers, standstill agreements or repayment holidays are often implemented to provide time for the restructuring process to be undertaken.

A debt restructure may involve a simple covenant reset or a rescheduling of the existing debt. However, if your business is significantly over geared, some form of debt conversion or forgiveness may also be available.

A debt for equity swap is an example of this, where a lender reduces or cancels their debt in return for equity in the restructured business. The process strengthens the business’s balance sheet and potentially gives the lender dividend entitlement or future upside in the event of the business being sold.

Formal compromise arrangements

If the above approaches cannot deliver a consensual solution, you can initiate a formal compromise process which is designed to help preserve the company and its ongoing business. These include Company Voluntary Arrangements (CVAs), Schemes of Arrangement (also known as Schemes) and Restructuring Plans (RPs).

CVAs, Schemes and RPs are all legal processes through which a company puts a proposal to creditors for a composition in satisfaction of its debts. Under these processes, creditors may agree to accept a deferment of repayment or accept a certain sum of money in full and final settlement of the debts or a combination of both.

These three processes are extremely flexible and the form which they take will depend on the situation, the financial structure of the business and the terms of the proposal to be agreed. There are fundamental differences between the processes which will determine which process is most appropriate for your business and situation.

CVAs are a formal insolvency process, conducted out of court and under the supervision of a Licenced Insolvency Practitioner. This process cannot bind a secured creditor and does not allow for creditors to be grouped into different classes for voting purposes.

Schemes and RPs are court driven processes under the Companies Act, both of which have the power to bind secured creditors and allow creditors to vote in classes. Unlike Schemes, however, RPs have the ability to be sanctioned by the court even if certain classes of creditor dissent giving the ability to “cram down” debt in relation to dissenting classes.

You may also be interested in our 9 things you need to do if cash is under pressure in your business article.