Long term creditors: converting liabilities to equity

Welcome to the fourth piece in our 'Building a resilient balance sheet for 2021' series looking at solutions and opportunities for 2021 viewed through the balance sheet. We now look at non-current liabilities.

Converting liabilities to equity

As companies need to improve their net asset position either to secure additional funding, to strengthen their balance sheet, or even to improve their credit rating, it might be attractive to convert some long-term liabilities to equity.  

If there is little prospect of the non-current liabilities being repaid in the short term, then strengthening the balance sheet by converting long term debt to a form of equity might better support the prospects of the business.  

Different types of equity

Preference shares

There are many different types of equity, some of which are not too far removed from the debt that they have replaced.  Preference shares, for example, can carry an annual coupon (interest payable) and can be redeemable at agreed times, or in agreed priority such as before ordinary shares on exit or winding up.  

Changes to a company’s share capital such as the introduction of preference shares may require changes to the articles of association. Any such changes may require the approval of 75% of those shareholders who are eligible to vote.  It may also require consents to be provided under a shareholders’ agreement if one exists.  Legal and tax advice should always be taken as there can be unintended but costly consequences of not planning the structure correctly.

Long term creditors will not always be willing or able to convert their debt to equity.  In our next post, we look at some ideas to engage with and manage longer-term creditors.