Debt to Equity Conversions: A brief practical overview.

What is Debt to equity conversion?

A debt-to-equity conversion is a method of debt restructuring where a creditor converts debt owed to it by a debtor company into shares in that company.

It is mainly done by companies facing financial difficulty but retains a large asset base and a large?balance sheet,?and insolvency will only create little value for the creditor.

By executing a debt-to-equity conversion the debtor company is able to reduce its debts and increase its capital thereby improving its financial condition through the recovery of solvency.

"Debt to equity conversion is a viable option if the debtor company is a going concern. It could be the company is profitable but due to certain market circumstances, it has failed to repay its loans."

?What are the key things to consider in debt-to-equity conversion?

The debtor company is usually at a disadvantage when it comes to debt-to-equity conversions. Since the creditor is the one taking a substantial risk, it will always negotiate to be in a position of greater control over the debtor company.

Now.....

There is no prescribed structure for a debt-to-equity conversion each transaction will be determined by the negotiations between the parties involved. However, the following are key things to be considered:

• a valuation of the company will need to be conducted to ascertain what amount of the debt will be converted into shares;
• Parties will also have to agree on the types of shares to be issued, and the rights and restrictions attached to the said shares;
• To what extent will the current shareholder’s shares be diluted depending on the size of the debt the creditor could end up being the majority shareholder; and
• Whether the shares will be issued at a discount or the current market value?

"the advantage to the creditor is that the creditor could end up of collecting more funds in the future, from dividends of the shares to be issued and sales of the shares than would be available if the creditor had waived the debt or proceeded to commence recover the loan."?

Legal work involved in a debt-to-equity conversion transaction?

Debt-to-equity conversions involve a considerable amount of legal work depending on what has been agreed by the parties the legal work will include:

• A debt-to-equity conversion agreement will need to be executed;
• Existing loan agreements between the creditor and debtor company may need to be amended to discharge debt converted to shares or discharge the whole debt where the whole debt will be converted to shares;
• The shareholder agreement (if any) may be amended to include the creditor as well as alter provisions as negotiated by the creditor and the shareholders of the borrower company;
• Obtaining consent from minority shareholders, possibly other creditors, and potentially even counterparties in important contracts where there are change in control provisions in the contract;
• Formalities for allotting new shares, – is this covered and permitted by the company’s articles? Does the company have enough unissued shares to accommodate the conversion or will the share capital need to be increased beforehand?-these will need to be resolved;
• Regulatory – The Registrar of companies will have to be notified through prescribed forms of the allotment and increase in share capital. if necessary. The Fair Competition Commission will need to be notified and approval sought if the conversion triggers the threshold for notification.
• Tax considerations share transfers are taxable transactions where capital gains tax is charged as well as change in control tax implications.

Disclaimer

The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available in this article are for general informational purposes only. If you require legal advice on the law and procedure for debt-to-equity conversion feel free to contact me at:?[email protected], +255656735345.