Sometimes, a company will need to go through some financial restructuring to better position itself for long-term success. One possible way to achieve this goal is to issue a debt/equity or an equity/debt swap.
What is a debt/equity swap?
A debt/equity swap is a transaction in which the obligations or debts of a company or individual are exchanged for something of value, equity. In the case of a publicly traded company, this generally requires an exchange of bonds for stock. The value of the stocks and bonds being exchanged is typically determined by the market at the time of the swap.
See Also: Ways to Get Rid of Debts
The value of the swap is determined usually at current market rates, but management may offer higher exchange values to entice share and debt holders to participate in the swap. After the swap takes place, the preceding asset class is called off for the newly acquired asset class.
Breaking down “debt/equity swap”
A debt/equity swap is a refinancing deal in which a debt holder gets an equity position in exchange for cancellation of the debt. The swap is generally done to help a struggling company continue to run. The logic behind this is a broke company cannot pay its debts or improve its equity standing.
Example of a Debt-to-Equity Swap
Here’s how it works: Corporation A might owe Lender X $10 million. Instead of continuing to make payments on this debt, Corporation A might agree to give Lender X $1 million or a 10 percent ownership share in the company in exchange for removing the debt.
Why Do Companies Use Debt/Equity Swaps?
In some cases, a business may offer its debt holders equity because the business does not want to or cannot pay the face value of the bonds it has issued. To put off repayment, it offers stocks instead.
In other cases, businesses have to keep certain debt/equity ratios, and inviting debt holders to swap their debts for equity in the company helps to adjust that balance. These debt/equity ratios are often part of financing requirements carried out by lenders. In still other cases, businesses use debt/equity swaps as part of their bankruptcy reform.
What Is the Difference Between Debt/Equity Swaps and Equity/Debt Swaps?
An equity/debt swap is the opposite of a debt/equity swap. Instead of trading debt for equity, shareholders swap equity for debt. Basically, they exchange stocks for bonds.
How Do Companies Entice Clients Into Debt/Equity Swaps?
In cases of bankruptcy, the debt holder does not have a choice about whether he wants to make the debt/equity swap. However, in other cases, he may have a choice in the matter. To entice people into debt/equity swaps, businesses often offer beneficial trade ratios.
See Also: Reasons that Make Debts Good
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