What Is a Debt/Equity Swap?
A debt/equity swap is a transaction where the obligations or debts of a company or individual are exchanged for something of value, to be specific, equity. On account of a public corporation, this generally involves an exchange of bonds for stock. The value of the stocks and bonds being exchanged not entirely settled by the market at the hour of the swap.
Understanding Debt/Equity Swaps
A debt/equity swap is a refinancing deal in which a debt holder gets a equity position in exchange for the cancellation of the debt. The swap is generally finished to assist a striving company with proceeding to operate. The logic behind this is a ruined company can't pay its debts or further develop its equity standing. Be that as it may, here and there a company may essentially wish to exploit positive market conditions. Contracts in the bond indenture might keep a swap from occurring without consent.
In cases of bankruptcy, the debt holder doesn't have a decision about whether he needs to make the debt/equity swap. Nonetheless, in different cases, he might have a decision regarding this situation. To tempt individuals into debt/equity swaps, businesses frequently offer advantageous trade ratios. For instance, in the event that the business offers a 1:1 swap ratio, the bondholder gets stocks worth the very same amount as his bonds, not a particularly advantageous trade. Nonetheless, on the off chance that the company offers a 1:2 ratio, the bondholder gets stocks valued at two times however much his bonds, making the trade seriously captivating.
Why Use Debt/Equity Swaps?
Debt/equity swaps can offer debt holders equity in light of the fact that the business would rather not or can't pay the face value of the bonds it has issued. To defer repayment, it offers stock all things considered.
In different cases, businesses need to keep up with certain debt/equity ratios and welcome debt holders to swap their debts for equity assuming the company assists with changing that balance. These debt/equity ratios are many times part of financing requirements forced by lenders. In different cases, businesses use debt/equity swaps as part of their bankruptcy restructuring.
Debt/Equity and Bankruptcy
In the event that a company chooses to declare bankruptcy, it has a decision between Chapter 7 and Chapter 11. Under Chapter 7, the business' all's debts are wiped out, and the business does not operate anymore. Under Chapter 11, the business proceeds with its operations while restructuring its finances. By and large, Chapter 11 reorganization drops the company's existing equity shares. It then reissues new shares to the debt holders, and the bondholders and creditors become the new shareholders in the company.
Debt/Equity Swaps versus Equity/Debt Swaps
An equity/debt swap is something contrary to a debt/equity swap. Rather than trading debt for equity, shareholders swap equity for debt. Basically, they exchange stocks for bonds. Generally, Equity/Debt swaps are directed to work with smooth mergers or restructuring in a company.
Illustration of a Debt/Equity Swap
Assume company ABC has a $100 million debt that it can't service. The company offers 25% percent ownership to its two debtors in exchange for discounting the whole debt amount. This is a debt-for-equity swap in which the company has exchanged its debt holdings for equity ownership by two lenders.
- Debt/equity swaps include the exchange of equity for debt to discount money owed to creditors.
- In a bankruptcy case, the debt holder is required to make the debt/equity swap, yet in different cases, the debt holder might opt to make the swap, gave the offering is a monetarily positive one.
- They are generally led during insolvencies, and the swap ratio among debt and equity can differ in view of individual cases.