Debt restructuring refers to the reallocation of resources or change in the terms of loan extension to enable the debtor to pay back the loan to the creditor. It is an adjustment made by both the debtor and the creditor to smooth out temporary difficulties in the way of loan repayment. It can be categorized into two types, and there are many ways to carry out the restructuring process.
Types
It is of two kinds, depending on the terms and the costs to the debtor.
1. General
Under the terms of general debt restructuring, the creditor incurs no losses from the process. The creditor decides to extend the loan period, or lowers the interest rate, to enable the debtor to recover from a temporary financial difficulty and pay the debt later.
2. Troubled
Troubled debt restructuring refers to the process where the creditor incurs losses in the process. This happens when it leads to a reduction in the accrued interest, a dip in the value of the collateral, or conversions to equity.
How to Plan
1. The creditor company should prepare a roadmap for the process. The strategy should include the expected time necessary to recover the debts, the terms of loan repayment, and watching the financial performance of the debtor.
2. The decision of the financial institution regarding it depends on whether the debtor has invested in the company, holds shares with the company, or is a subsidiary of the company.
3. If there is conflict within the company’s board of directors regarding the process, then it is advisable to ask for help from a third party. However, third party mediation should not be necessary if the debtor is a subsidiary of the company.
4) Making a cash flow projection is also important to the process. It is advisable not to include uncertain cash flow estimates in the plan.
5) The debtor’s financial situation should also be considered, when making a plan. The debtor’s ability to repay the loan depends on the financial management, so the financial company needs to look into the debtor’s roadmap for repaying loans. If the debtor is another company, then changing the key people associated with it, like the director, board of directors or chairperson might help.
Additional Help
If you are planning for debt restructuring, as a creditor or a borrower, you can approach a small business consultant for help.
Final Thoughts
Debt restructuring depends on many factors like the debtor’s financial management, the projected cash inflow, and the relationship between the debtor and the creditor. It is meant to help both the parties. It involves compromises made by the creditor as well as the debtor to ensure that the loan is repaid in full to the creditor without too much of a financial loss to the debtor.
David Gass is President of Business Credit Services, Inc. His company publishes a free weekly e-newsletter on Small Business Consulting at their web site smallbusinessconsultingdotcom