Debt can be an overwhelming force for businesses to contend with.It is paid on a regular basis and is not calibrated based on the business environment. No matter what, creditors expect to be paid in full and on time. They are legally entitled to these payments. If they don’t receive them, a bankruptcy could resulting in creditors will repossessing the assets of the firm, the real estate or the equity in the underlying company. These results are very bad for the management team and could result in losing their jobs. Their are several key benefits to restructuring debt.
Staying in Business Long Enough to Reach Hyper Growth in the Future
Even companies that have a bright future still need to pay those quarterly or yearly debt payments. If they can’t make ends meet to make those payments before major growth sets in, they may never have the opportunity to reach the pot of gold at the end of the rainbow.
For example, a company may be developing a killer new software product. The research and development costs may be $15 million this year with net income $20 million and debt payments of $12 million. They expect the new software will produce an additional profit $15 million per year for the next 5 years. If the company has low cash savings, they may choose to restructure the debt rather than pay it all on time. Ideally they could pay a lower interest rate now and a higher rate later. However, they may also give up some equity in the transaction.
Debt Payments Lowered
One way of restructuring debt allows for lower interest payments. These regular payments are costly to the firm and do not have any benefit to the core operations of the firm. In fact, this is usually the number one point of negotiation when companies take on debt in the beginning. They are taking on the lowest interest rate possible for the cash that they receive.
Creditors that want to avoid bankruptcy are often willing to lower the debt payment. This negotiation can be tense because a bankruptcy is on the table for the company, which makes the repossession process a long, drawn out legal battle that may or may not get back all the money lent. On the other hand, creditors can threaten to take over the company through their own declaration of bankruptcy and take control of the bank accounts to get their cash. Nobody wants this result so payments are usually worked out to a lower rate.
Debt Repayment Schedule Increased
When companies are facing bankruptcy, creditors are sometimes willing to negotiate a restructuring rather than going through the pain of trying to repossess everything and sell it. That may actually result in less value the creditors over time.
Instead, lenders are sometimes willing to lower interest rate payments in exchange for increasing the length of time that payments must be made. The result is more interest paid to the creditors over time. However, the firm remains viable and paying its regular payments.
Management Keeps Their Tenure
Lastly, restructuring allows management to stay in place to see through the changes negotiated with the lenders. They understand the vision for the firm and the ways they expect to maximize the business in order to generate the cash to pay back the loan. If new management were brought in, they may not understand quite how to use every lever in the business to achieve profitability. For that reason, restructuring usually allows the existing management to stay in leadership for a longer period of time.
Apollo Business Advisors is a leading business and investment consulting firm. The team has years of experience helping large companies with their restructuring needs. For more information, please contact us.