Debt for equity swaps - guide for UK private companies

What is a debt for equity swap?

A debt for equity swap is a financial transaction where a company exchanges its debt obligations with equity shares. In simple terms, the company converts its debt into ownership shares. Debt for equity swaps have 2 main drivers :-

• A lender has rights to convert debt to equity and triggers the right

• The company instigates a debt for equity swap, to reduce financial pressure or to restructure capital.

How does a debt for equity swap work?

• Valuation - the value of the debt is assessed, and a corresponding number of equity shares is determined.

• Shares are issued - the company issues new shares to the debt holders.

• Debt cancellation - the debt is extinguished in exchange for the newly issued shares.

Lender decides to convert

A specific event, such as a default or a predetermined date, may trigger the conversion option and the debt instrument will specify the conversion ratio, which determines how many shares the creditor will receive for each unit of debt.

Creditors may choose to exercise a pre-existing option to convert for reasons including :-

• To protect investment - if the company's financial health deteriorates, creditors may prefer to convert their debt to equity to protect their investment.

• Control - by converting debt to equity, creditors may gain control of the company, especially if the conversion results in a significant ownership stake.

• Potential for higher returns - if the company's prospects improve, the value of the equity may increase, potentially yielding higher returns than the original debt investment.

It's important to note that the specific terms and conditions of the conversion option will vary depending on the individual debt instrument. Seeking legal and financial advice is crucial to understand the implications of a debt for equity swap and to ensure compliance with relevant regulations.

Why would a private company consider a debt for equity swap?

• Financial pressures - to avoid insolvency or bankruptcy, companies may opt for a debt for equity swap to reduce debt burden.

• Restructuring - to improve the company's capital structure and financial health.

• Investor relations - to attract new investors and strengthen relationships with existing ones.

• Tax Implications - in certain circumstances, debt for equity swaps can offer tax advantages.

Commercial and tax implications

• Dilution of ownership - existing shareholders may experience dilution of their ownership stake.

• Loss of control - depending on the percentage of shares issued, control of the company may shift to the debt holders.

• Valuation challenges - accurately valuing the debt and determining the appropriate share price can be complex.

• Tax consequences - Stamp duty land tax (SDLT) may be payable on the issue of shares. Capital gains tax (CGT) may arise for debt holders if the swap results in a gain.

• Corporate tax - the swap may have implications for corporation tax, particularly if it involves a debt write-off.

Legal steps and work involved

• Board approval - board of directors must approve the debt for equity swap.

• Shareholder approval - shareholder approval may be required, particularly if the swap significantly impacts the company's capital structure.

• Share purchase agreement - outlining the terms of the share issue.

• Debt cancellation agreement - documenting the cancellation of the debt.

• Valuation - the value of the debt and the number of shares to be issued must be determined.

• Share issue - the company must issue new shares to the debt holders.

• Debt cancellation - the debt instruments must be cancelled or extinguished.

• Filing with Companies House - the company must file the necessary documentation with Companies House, including a return of allotment of shares.

• Tax Considerations - ensure compliance with tax regulations and consider seeking tax advice to optimize the tax implications.

How we can help

A debt for equity swap is a complex legal and financial transaction. It is essential to seek advice from experienced corporate lawyers to ensure compliance with all relevant laws and regulations. We can assist with:

• Structuring the transaction to minimise tax implications.

• Drafting the legal documents.

• Obtaining shareholder and regulatory approvals.

• Ensuring compliance with corporate governance rules.

• Managing potential legal risks and disputes.

By carefully considering the legal and commercial implications and seeking expert advice, companies can effectively implement a debt for equity swap to improve their financial position and achieve strategic goals.