When should a business consider a debt for equity swap?

A debt for equity swap is a method of restructuring often employed when a company runs into severe financial trouble. In a nutshell, it is when creditors agree to write off debt in return for equity in the company. Debt for equity swaps are pretty common, increasingly so in the retail world. 

In more buoyant, aggressive times they are sometimes the route used by private equity funders to effectively take control of a business – insisting that new funding must be in exchange for a majority equity stake – and marginalise founder director/shareholders who may have different ambitions from maximising short- to mid-term shareholder value.  Even in more straitened times they can be used in the same way if there is a feeling that a particular brand or market has a limited shelf-life. If the business is not listed nor already subject to media scrutiny, it is also a strategy that can be effected quietly and without damaging PR.   

On the other hand, and being less cynical, debt for equity swaps can be utilised to show continued support by the creditor(s) for the business. That can be a very positive message and usually means things like more continuity for the business and greater retention of staff, rather than the alternative of triggering a financial default and forcing a sale through administration. Particularly if coupled with a change in management and business strategy, this can buy the time and financial space to put through those changes and revise the fortunes of the business and brand. 

A third scenario is that, if full repayment of the debt is unlikely and there are no prospective purchasers for the business on the market, funders are left with little other option. In this case, a debt for equity swap is generally part of a slow death. At the very least, it gives creditors (particularly landlords in the retail sector) an opportunity to rationalise their own business models before more stringent measures such as company voluntary agreements (CVAs) or administration are brought into play. These measures often cause greater pain to landlords and other creditors – as has been documented well in the media.

Alexander Wood, Partner – Restructuring & Insolvency, Coffin Mew