Issuing new shares
A debt for equity swap will usually be effected through the issue of new shares in a company to its lenders. These could be either an existing class of shares, or a new class, sometimes with conversion rights into existing shares. The result would be the dilution of existing shareholders to the agreed level.
For non-listed companies, where the number of shareholders is usually small, the issue of new shares to the lenders would be agreed as part of the overall restructuring.
For publicly quoted companies, the issue of new shares is affected by the local stock exchange regulations. In addition, the existing shareholders would normally be offered the opportunity to subscribe for new shares pro rata to their existing holdings to meet their pre-emption rights, where such rights exist. If more than one class of new shares are being issued, these would usually be packaged into ‘units’. Any shares not taken
up by existing shareholders would be subscribed for by lenders in exchange for debt.
Pre-emption can be valuable in negotiations as the shareholders will in effect have the opportunity to avoid dilution by subscribing for the company’s shares on the same terms as those offered to its lenders.
Generally, lenders will be subscribing for shares at a substantial premium to the prevailing market price, principally to recognise the implicit discount in the value of the debt being converted. As a result, it is extremely rare that the existing shareholders will subscribe for shares at the same price as lenders. If an equity fund raising exercise is conducted at the same time as an exchange, non-lender subscribers would be offered shares at a lower price than that being ‘paid’ by the lenders.
Other methods of achieving the desired shareholding by the lenders might be possible, such as:
- Acquisition of the appropriate number of shares from existing shareholders for a
nominal consideration. - Deferral or cancellation of the required number of existing shares.
Usually, however, such mechanisms tend to add considerable complexity to the transaction, and are therefore avoided unless there is a particular need to pursue them.
In addition, statutory provisions may also be available to implement a debt for equity swap through the courts. Strictly, however, they fall outside the scope of a ‘voluntary’ loan restructuring.