What is Debt Restructuring?
Debt restructuring is a process that companies undergo when they cannot meet their financial obligations as they come due. It involves altering the terms of the company's existing debt to make repayment more manageable. This can be done by adjusting the interest rate, extending the repayment term, or reducing the principal amount owed. Successful debt restructurings or business recapitalizations are generally good options before declaring bankruptcy.
There are two main reasons why a company may need to restructure its debt. One common cause is a decline in revenue. If a company's revenue decreases, so does its cash flow, causing it to struggle to meet its debt obligations. A revenue decline can happen for various reasons, such as increased competition, economic downturns, or changes in consumer preferences.
The other reason a company may need to restructure is high debt levels. If a company has taken on too much debt relative to its cash flow, it may be difficult to make its debt payments. This can lead to a downward spiral, making the company's debt burden increasingly unsustainable.
If a debt restructuring does not seem like a viable option, as it only delays the problem and causes the remaining equity in the business to erode, then a better way to move forward is to improve the balance sheet through a recapitalization. This would involve replacing all or part of the existing debt with fresh capital. This would help the business to eliminate or reduce the debt burden, enabling it to generate enough cash flow to stay alive and eventually grow out of its proverbial “hole”. However, this would mean taking a new equity partner in the business, which is something the business owner would have to evaluate
Overall, debt restructuring is a process designed to help companies manage their debt obligations when they are struggling financially. While it can be a difficult process, it can also be an effective way to help companies get back on track and become financially stable once again. The key to avoiding financial distress is to proactively manage the business's cash flows to ensure a proper coverage ratio against the company’s debt obligations.