Financial distress is a term in Corporate Finance Corporate finance is an area of finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the used to indicate a condition when promises to creditors A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption (usually enforced by contract) that the second party will return an equivalent property or service. The second of a company are broken or honored with difficulty. Sometimes financial distress can lead to bankruptcy Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by. Financial distress is usually associated with some costs to the company; these are known as costs of financial distress.

Contents

Cost of financial distress

A common example of a cost of financial distress is bankruptcy costs. These direct costs include auditors' fees, legal fees, management fees and other payments. Cost of financial distress can occur even if bankruptcy is avoided (indirect costs):

The payout diagrams for bondholders...

Financial distress in companies can lead to problems that can reduce the efficiency of management. As maximizing firm value and maximizing shareholder value Shareholder value is a business buzz term, which implies that the ultimate measure of a company's success is to enrich shareholders. It became popular during the 1980s, and is particularly associated with former CEO of General Electric, Jack Welch. In March 2009, Welch openly turned his back on the concept, calling shareholder value "the cease to be equivalent managers who are responsible to shareholders might try to transfer value from creditors to shareholders.

...and shareholders in case of liquidation show the reason for a conflict of interests.

The result is a conflict of interest between bondholders (creditors) and shareholders. As a firm's liquidation value slips below its debt, it is the shareholder's interest for the company to invest in risky projects which increase the probability of the firm's value to rise over debt. Risky projects are not in the interest of creditors, since they also increase the probability of the firms value to decrease further, leaving them with even less. Since these projects do not necessarily have a positive net present value In finance, the net present value or net present worth (NPW) of a time series of cash flows, both incoming and outgoing, is defined as the sum of the present values (PVs) of the individual cash flows. In case when all future cash flows are incoming (such as coupons and principal of a bond) and the only outflow of cash is the purchase price, the, costs may arise from lost profits Opportunity cost is the cost related to the next-best choice available to someone who has picked between several mutually exclusive choices. It is a key concept in economics. It has been described as expressing "the basic relationship between scarcity and choice." The notion of opportunity cost plays a crucial part in ensuring that.

Equally, management might chose to prolong bankruptcy, which has the same effect on probabilities of a change in the firm's value. Management might also distribute high dividends to "save" money from the creditors.

Another source of indirect costs of financial distress are higher costs of capital: Short-term loans by contractors and banks are expensive and difficult to obtain.

Valuation

Companies in financial distress undergo corporate restructuring Restructuring is the corporate management term for the act of reorganizing the legal, ownership, operational, or other structures of a company for the purpose of making it more profitable, or better organized for its present needs. Alternate reasons for restructuring include a change of ownership or ownership structure, demerger, or a response to where valuations are used as negotiating tools. This distinction between negotiation and process is a difference between financial restructuring and corporate finance Corporate finance is an area of finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the.

Additional modifications to a valuation approach, whether it is market-, income- or asset-based, may be necessary in some instances. There are other adjustments to the financial statements that have to be made when valuing a distressed company.[1]

Options for Relieving Financial Distress

Debt restructuring Debt restructuring is a process that allows a private or public company – or a sovereign entity – facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity and rehabilitate so that it can continue its operations is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress, to reduce and renegotiate its delinquent debts in order to improve or restore liquidity In accounting, liquidity is a measure of the ability of a debtor to pay his debts as and when they fall due. It is usually expressed as a ratio or a percentage of current liabilities and rehabilitate so that it can continue its operations.

If promises to creditors cannot be kept, bankruptcy Bankruptcy is a legally declared inability or impairment of ability of an individual or organization to pay its creditors. Creditors may file a bankruptcy petition against a business or corporate debtor in an effort to recoup a portion of what they are owed or initiate a restructuring. In the majority of cases, however, bankruptcy is initiated by is an option for both companies and individuals. In the United Kingdom The United Kingdom of Great Britain and Northern Ireland[note 7] is a sovereign state located off the northwestern coast of continental Europe. It is an island country, spanning an archipelago including Great Britain, the northeastern part of the island of Ireland, and many small islands. Northern Ireland is the only part of the UK with a land, the Individual Voluntary Arrangement The IVA was established by and is governed by Part VIII of the Insolvency Act 1986 and constitutes a formal repayment proposal presented to a debtor's creditors via an Insolvency Practitioner. Usually the IVA comprises only the claims of unsecured creditors, leaving the rights of secured creditors largely unchanged is a formal alternative to bancruptcy for individuals.

References

  1. ^ Joseph Swanson and Peter Marshall, Houlihan Lokey Houlihan Lokey is an international investment bank that advises middle-market and large public and private companies. Its main service lines include mergers and acquisitions, financial restructuring, financial opinions, and valuations and Lyndon Norley, Kirkland & Ellis International LLP (2008). A Practitioner's Guide to Corporate Restructuring, Andrew Miller’s Valuation of a Distressed Company page 24. ISBN 9781905121311

External links

Corporate finance Corporate finance is an area of finance dealing with financial decisions business enterprises make and the tools and analysis used to make these decisions. The primary goal of corporate finance is to maximize corporate value while managing the firm's financial risks. Although it is in principle different from managerial finance which studies the and investment banking An investment bank is a financial institution that assists corporations and governments in raising capital by underwriting and acting as the agent in the issuance of securities. An investment bank also assists companies involved in mergers and acquisitions, divestitures, etc. Further to provide ancillary services such as market making and the
Capital structure In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and 80% Senior secured debt A secured loan is a loan in which the borrower pledges some asset as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral — in the event that the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain · Senior debt In finance, senior debt, frequently issued in the form of senior notes or referred to as senior loans, is debt that takes priority over other unsecured or otherwise more "junior" debt owed by the issuer. Senior debt has greater seniority in the issuer's capital structure than subordinated debt. In the event the issuer goes bankrupt, · Second lien debt Second Lien Loan is a form of loan with a security interest in the assets of a company that are second in ranking behind a traditional senior credit facility. A lien is a form of security interest granted over an item of property to secure the payment of a debt · Subordinated debt In finance, subordinated debt is debt which ranks after other debts should a company fall into receivership or be closed · Mezzanine debt Mezzanine capital, in finance, refers to a subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of the common shares. Mezzanine financings can be structured either as debt or preferred stock · Convertible debt In finance, a convertible note is a type of bond that the holder can convert into shares of common stock in the issuing company or cash of equal value, at an agreed-upon price. It is a hybrid security with debt- and equity-like features. Although it typically has a low coupon rate, the instrument carries additional value through the option to · Exchangeable debt In finance, an exchangeable bond is a straight bond with an embedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under prescribed conditions. An exchangeable bond is different from a convertible bond. A convertible bond gives · Preferred equity Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument. Preferreds are senior to common stock, but are subordinate to bonds · Warrant In finance, a warrant is a security that entitles the holder to buy stock of the issuing company at a specified price, which can be higher or lower than the stock price at time of issue · Shareholder loan Shareholder loan is a debt-like form of financing provided by shareholders. Usually, it is the most junior debt in the company's debt portfolio, and since this loan belongs to shareholders it should be treated as equity. Maturity of shareholder loans is long with low or deferred interest payments. Sometimes, shareholder loan is confused with a · Common equity The stock or capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in · Pari passu In law, this term is commonly used as legal jargon. Black's Law Dictionary defines pari passu as "proportionally; at an equal pace; without preference."
Transactions (terms / conditions)
Equity offerings The stock or capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors. Stock is distinct from the property and the assets of a business which may fluctuate in Initial public offering (IPO) An initial public offering referred to simply as an "offering" or "flotation," is when a company (called the issuer) issues common stock or shares to the public for the first time. They are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to · Secondary Market Offering (SEO) A follow-on offering is an issuance of stock subsequent to the company's initial public offering. A follow-on offering can be either of two types (or a mixture of both): dilutive and non-dilutive (as rights issue). Furthermore it could be a cash issue or a capital increase in return for stock · Follow-on offering A follow-on offering is an issuance of stock subsequent to the company's initial public offering. A follow-on offering can be either of two types (or a mixture of both): dilutive and non-dilutive. A secondary offering is an offering of securities by a shareholder of the company (as opposed to the company itself, which is a primary offering). A · Rights issue Under a secondary market offering or seasoned equity offering of shares to raise money, a company can opt for a rights issue to raise capital. The rights issue is a special form of shelf offering or shelf registration. With the issued rights, existing shareholders have the privilege to buy a specified number of new shares from the firm at a · Private placement A '''private placement''' is a funding round of securities which are sold without a initial public offering, usually to a small number of chosen private investors. In the United States, although these placements are subject to the Securities Act of 1933, the securities offered do not have to be registered with the Securities and Exchange · Spin off The common definition of spin-out is when a division of a company or organization becomes an independent business. The "spin-out" company takes assets, intellectual property, technology, and/or existing products from the parent organization · Spin out The common definition of spin-out is when a division of a company or organization becomes an independent business. The "spin-out" company takes assets, intellectual property, technology, and/or existing products from the parent organization · Equity carve-out · Greenshoe A greenshoe , legally called an "over-allotment option" (the only way it can be referred to in a prospectus), gives underwriters the right to sell additional shares in a registered securities offering at the offering price, if demand for the securities exceeds the original amount offered. The greenshoe can vary in size up to 15% of the (Reverse A Reverse Greenshoe is a special provision in an IPO prospectus, which allows underwriters to sell shares back to the issuer. If a 'regular' greenshoe option is, in fact, a call option written by the issuer for the underwriters, a reverse greenshoe is a put option) · Book building Book building refers to the process of generating, capturing, and recording investor demand for shares during an IPO in order to support efficient price discovery. Usually, the issuer appoints a major investment bank to act as a major securities underwriter or bookrunner. The “book” is the off-market collation of investor demand by the · Bookrunner In investment banking, a bookrunner is usually the main underwriter or lead-manager/arranger/coordinator in equity, debt, or hybrid securities issuances. The bookrunner usually syndicates with other investment banks in order to lower its risk. The bookrunner is listed first among all underwriters participating in the issuance. When more than one
Mergers and acquisitions The phrase mergers and acquisitions refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity Takeover In business, a takeover is the purchase of one company by another (the acquirer, or bidder). In the UK, the term refers to the acquisition of a public company whose shares are listed on a stock exchange, in contrast to the acquisition of a private company · Reverse takeover Reverse takeover is the acquisition of a public company by a private company to bypass the lengthy and complex process of going public. The transaction typically requires reorganization of capitalization of the acquiring company · Tender offer Tender offer is a corporate finance term denoting a type of takeover bid. The tender offer is a public, open offer or invitation by a prospective acquirer to all stockholders of a publicly traded corporation (the target corporation) to tender their stock for sale at a specified price during a specified time, subject to the tendering of a minimum · Proxy fight · Poison pill Poison pill is a term referring to any strategy, generally in business or politics, to increase the likelihood of negative results over positive ones for a party that attempts any kind of takeover. It derives from its original meaning of a literal poison pill carried by various spies throughout history, taken when discovered to eliminate the · Freeze-out merger A freeze-out merger is a technique by which one or more shareholders who collectively hold a majority of shares in a corporation gain ownership of remaining shares in that corporation · Tag-along right A tag-along right is a legal concept in corporate law. The right assures that if the majority shareholder sells his stake, minority holders have the right to join the deal and sell their stake at the same terms and conditions as would apply to the majority shareholder. This right protects minority shareholders. Tag-along rights are fairly standard · Drag-along right Drag-Along Right is a legal concept in corporate law. The right assures that if the majority shareholder sells his stake, minority holders are forced to join the deal. This right protects majority shareholders. Drag-along rights are fairly standard terms in a stock purchase agreement. Drag-along rights typically terminate upon an initial public · Pre-emption right · Control premium Control premium is an amount that a buyer is usually willing to pay over the current market price of a publicly traded company. This premium is justified by the expected synergies, such as the expected increase in cash flow resulting from cost savings and revenue enhancements achievable in the merger. Normally, the control premium is industry- · Due diligence · Divestment · Sell side · Buy side · Demerger
Leverage Leveraged buyout · Leveraged recap · Financial sponsor · Private equity · Bond offering · High-yield debt · DIP financing · Project finance
Valuation Financial modeling · Free cash flow · Business valuation · Fairness opinion · Stock valuation · APV · DCF · Net present value (NPV) · Cost of capital (Weighted average) · Comparable company analysis · Enterprise value · Tax shield · Minority interest · Associate company · EVA · MVA · Terminal value · Real options analysis
List of investment banks · List of finance topics

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