Restructuring Debt to Ready Your Business for Sale or Merger
Why Debt Restructuring Matters for an Exit
When selling or merging your business, buyers will conduct thorough due diligence on your company’s finances. High debts levels relative to earnings immediately raise red flags for buyers and can dramatically reduce your business’s valuation. Even if you do find an interested party, you’ll likely have to accept a lower price or less favorable deal terms to compensate the buyer for inheriting significant liabilities.
-Conversely, reducing your debt burden makes your company a much more attractive target. Buyers and investors love seeing businesses with clean balance sheets and healthy cash flows unencumbered by excessive interest expenses or looming principal payments. Proactively restructuring debts to clean up your finances demonstrates sound management and gives buyers confidence in your company’s future prospects.
Getting Started with a Hardship Letter
The first step in renegotiating your debts is drafting an official “hardship letter” for creditors explaining why your company needs relief. Back up your request with supporting data like financial statements, tax returns, cash flow projections, business valuation estimates, and documentation of any extenuating circumstances. Provide creditors with a complete picture of why your current debt load is unmanageable and how it impedes plans to sell or merge the business.
When making your case, emphasize that everyone stands to benefit from a restructured agreement that puts your company on steadier footing. Appeal to creditors’ self-interest in getting repaid rather than facing a messy default or bankruptcy. Approach negotiations in good faith without threats or unreasonable demands. With a constructive tone and open communication, many creditors will be surprisingly willing to work with you.
Key Elements of Debt Restructuring Agreements
If creditors agree your business warrants relief, you’ll negotiate revised terms tailored to your situation. Some potential changes include:
-- Lower Interest Rates – Getting creditors to reduce rates even by just a few percentage points can dramatically cut interest expenses. This frees up cash flow to pay down principal or reinvest in growth.
- Extended Maturities – Pushing back final balloon payments by months or years reduces liquidity strain and gives you more time to improve profitability.
- Principal Reductions – Creditors may agree to cut a portion of what you owe in exchange for regular payments on the remaining balance.
- Collateral Releases – Secured creditors could remove liens on key business assets to facilitate a sale.
- Penalty & Fee Waivers – Suspending late fees, default interest premiums, or other charges provides immediate relief.
Though every situation is different, even modest changes like the above can shore up your financial footing and demonstrate progress to potential buyers.
Seeking Outside Help to Broker Deals
Trying to negotiate complex debt restructurings on your own is extremely difficult, especially for small business owners lacking financial expertise. Fortunately, expert advisors can help guide you through the process and advocate on your behalf with creditors.
Specialty finance lawyers excel at documenting detailed hardship claims and using their negotiating leverage to win concessions. They identify pressure points for each creditor relationship and craft tailored solutions aligned with your end goals. For more complex cases, specialized restructuring advisory firms add their operational know-how and extensive lender relationships to the mix.
Though enlisting outside help adds some upfront cost, it almost always pays dividends in the backend through significantly better deal terms that easily justify the investment. Think of advisor fees as a wise insurance policy enabling transactions that may otherwise never materialize.
What About Filing for Bankruptcy?
If voluntary negotiations with creditors break down, filing for bankruptcy protection under Chapter 11 or Chapter 7 of the U.S. tax code remains an option. The court supervises the bankruptcy process and has powers to compel reluctant creditors to accept debt reductions or payment extensions. While this legal route provides great leverage to eliminate debts, it also comes with major drawbacks for business owners looking to sell or merge their company down the road.
-Bankruptcy filings intrinsically damage businesses’ reputations among customers, partners, and investors. The stigma of past financial troubles sticks with companies for years and can ward off potential acquirers regardless of current financial health. Many buyers also shy away from taking on the lingering court supervision and extra administrative hurdles typical in bankruptcy proceedings.
For these reasons, negotiating debt relief outside formal legal channels is generally preferable for owners hoping to eventually exit their businesses. Reserve bankruptcy as an absolute last resort if consensual deals prove impossible.
What Buyers Care About in Due Diligence
Once you complete restructuring agreements with major creditors, documenting the changes in due diligence materials for potential buyers is critical. Key items to showcase include:
-- Updated Financial Statements – Provide balance sheets, income statements, and cash flow statements reflecting debt reductions and more sustainable interest expenses going forward. Quantify the positive impact on profitability and cash generation.
- Proof of Restructured Terms – Share copies of new loan agreements, promissory notes, and collateral releases evidencing agreed changes. Getting liens removed from key real estate or equipment is especially valuable.
- Projected Performance Improvements – Model projected earnings increases, debt service savings, and enhanced valuation multiples stemming from the restructurings. Back up assumptions with credible analysis.
Drawing attention to these positive outcomes during due diligence mitigates concerns new investors might otherwise have around past financial troubles.
Recap of Key Benefits
While tackling debt restructurings certainly isn’t easy or fun, the potential benefits for business owners hoping to exit via a sale or merger make the effort well worthwhile:
- Attract buyers wary of excess leverage or credit problems
- Negotiate more favorable valuation and transaction terms
- Reduce interest expenses to drive profit growth
- Extend maturities to ease liquidity pressures
- Eliminate liens interfering with future plans
- Avoid reputation damage and court oversight of bankruptcy
With expert advisors guiding the process, most businesses can reshape unmanageable debt burdens into catalysts for a successful next chapter. The peace of mind that comes from regaining control of your financial destiny will be well worth the short-term growing pains.