Vol 2 (2005) - Issue 1

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The Use of Corporate Finance Tools in Restructuring

Companies facing immediate or anticipated financial difficulty have various courses of action open to them to stabilize their activities and prepare their balance sheets in order to raise sufficient funds to carry on business and improve cash-flow. At the same time they must ensure that their directors avoid the penalties they may incur if the company trades while insolvent. This article explores the various alternatives open to a company in such a position in the United Kingdom. Analogous alternatives are generally available in other developed jurisdictions. The best solution for any particular company may in fact be a combination of the options explored.

The most obvious option is to raise debt finance from external sources. Financial institutions offer various finance tools including overdraft facilities (which may be unsecured, secured, or guaranteed), medium- or long-term loans, receivables finance, and the possibility of restructuring current indebtedness.

Unsecured overdraft facilities are short-term in nature and are generally repayable on demand. A company facing immediate or anticipated financial difficulty will often have an overdraft facility that is fully drawn. Increasing the facility would give the company temporary breathing space but would not cure fundamental problems. Also, a lending institution that perceives a company to be facing financial difficulty is more likely to require security from the company, guarantees from the company’s shareholders, or guarantees from other companies within the group in return for the increase. The company’s balance sheet will show the overdraft as a current liability.

If all of the company’s debt is repayable on demand then the company may seek to restructure its current indebtedness. The company’s lender can agree to convert part of its current indebtedness into a medium- or a long-term debt, may grant a repayment holiday, and may additionally or alternatively grant an interest holiday for a limited period of time.

It is common for lending institutions to calculate interest payable on an overdraft on a daily basis, at a fixed percentage above its base rate. Furthermore, most lending institutions charge a fee for the provision of overdrafts, and so overdrafts are an expensive manner through which to obtain finance. It is also common for the lending institution to grant the overdraft on condition that the company repays, or ‘cleans up’, the overdraft in full on a regular basis, to reassure the institution that the overdraft facility which it is providing to the company is being used for the purpose for which it is intended, namely, for effective cash-flow management. If the company is truly struggling with its cash-flow then this clearly will not be possible.
As an alternative to the overdraft facility, the company may approach its lender for a ‘term loan’. This will be negotiated and structured so that the company receives a specified sum which is repaid to the lender over a set period. The company will be able to use the sum to meet its requirements for working capital, and will repay it in various instalments. The company will want to negotiate a programme of repayment that will not detract from its need to boost cash-flow in the short term, and there are various ways in which the repayments may be structured.

Typically, the sum that the company borrows from a term loan facility will be available to the company for a set period after the execution of the loan agreement. During this period, the company will be permitted to ‘draw down’ sums of cash in ‘tranches’. This is clearly of benefit to the company with a shortage of ready cash, since it can borrow only such sums that it requires to meet its short-term obligations. The company also benefits from minimized interest on the borrowing, being able to repay that interest over the course of manageable periods of time, and being able to avoid any penalties for late payment of its short-term obligations, for example to suppliers.

Prior to entering into the term loan agreement, the company and the lender will have agreed the timetable and nature of repayment of the borrowing. There are various ways of structuring the repayments, which they may have agreed upon. The most common are amortization, balloon repayments, and bullet repayments. Where the repayments are amortized, the company repays a set proportion of the borrowing at regular periods over the repayment period. The company may have been able to persuade the lending institution to agree to a repayment holiday before the first repayment is due, giving the company further breathing space.