Capital raising is a critical time for any startup. Take control of your startup’s equity with this free cap table template.<\/p>\n <\/div>\n \n\nDownload Now<\/a> <\/section>\n <\/div>\n\n\n\n\n Debt represents the amount your company must repay in the future, usually with interest. Equity is a measure of ownership represented by shares issued in the company. Most companies grow by issuing a mixture of debt and equity financing<\/a>, with both forms of financing having their pros and cons. <\/p>\n\n\n\n In some cases, your company may have borrowed money through a loan instrument that contains a provision allowing the lender to \u201cswap\u201d the debt for equity. Alternatively, the lender may ask your company to convert the loan amount to equity. Finally, you may even approach your company\u2019s lender and see if they would be willing to swap the outstanding debt for equity. <\/p>\n\n\n\n Regardless, if your company\u2019s debt is swapped for equity, a portion of the debt will be written off in exchange for a corresponding amount of shares in your company (i.e. equity). <\/p>\n\n\n\n The lender will often be issued different class shares (e.g. preference shares<\/a>). This can often happen in the context of restructuring or refinancing, for instance, if your company is in financial stress and failing to pay its debts. <\/p>\n\n\n\n Debt-for-equity agreements are sometimes called \u201cconvertible loans\u201d or \u201cpayments in kind\u201d (\u201cPIKs\u201d).<\/p>\n<\/div>\n\n\n\n The primary commercial considerations that you will need to work out with your lender when it comes to swapping your debt for equity include the following:<\/p>\n\n\n\n In some cases, the terms of the loan will specify these questions. But in other cases, this is a matter of negotiation based on your position and the lender’s. If you are open to your lender exchanging debt for equity in the future, it may be advantageous to negotiate this when you agree on the loan terms. If you wait till your company is in financial stress and approach the lender to request a debt for equity exchange, your bargaining position will be much weaker, and you may need to agree to less favourable terms.<\/p>\n\n\n\n If you do not have a convertible note with the lender and the company and the lender have agreed to swap the debt for equity, then you will need to document an agreement with the following information:<\/p>\n\n\n\n In practice, you should execute this agreement as a \u201cdeed of release.\u201d This is simply a more formal way of recording this agreement. <\/p>\n\n\n\n In the simplest of swaps, the process is fundamentally no different than issuing new shares<\/a>:<\/p>\n\n\n\n In many cases, the lender will want their special class of shares. Such shares are commonly called \u201cpreference shares\u201d because they give lenders preferential treatment over other classes of shareholders. Most commonly, such preference shares will stipulate:<\/p>\n\n\n\n Additionally, from your lenders\u2019 perspective, they will want the class of shares issued to them to behave like the initial loan. Your company can achieve this by negotiating certain redemption rights and dividends. <\/p>\n\n\n\n Usually, preference shares do not grant the shareholder voting rights.<\/p>\n<\/div>\n\n\n\n The mechanics of how share redemptions operate are beyond the scope of this article. But in general, redemption rights in shares give the relevant class of shareholders the right to \u201credeem\u201d their shares for cash.<\/p>\n\n\n\n This means that your lender can exercise the right to redemption after a set period or upon the happening of some event. Accordingly, your company will pay a specified amount per share back to the lender.<\/p>\n<\/div>\n\n\n\n The effect is similar to being repaid the principal sum of a loan. Redemption rights can specify a repayment amount higher than the original share price. For this reason, swapping debt for equity can be advantageous to the lender if they think the company’s underlying value will increase over time. <\/p>\n\n\n\n It is common for the preference shares to give the lender the right to dividend payments at a fixed rate. You may notice the effect is similar to interest payments: i.e. the lender will receive a fixed amount over a specific period. <\/p>\n\n\n\n However, dividends differ from interest payments in one critical way. Importantly, your company cannot issue dividends unless it has made a profit. Therefore, compared to debt, this is advantageous to your company because there is no obligation to make a payment unless your company is doing well enough to turn a profit. <\/p>\n\n\n\n Keep in mind that parties may negotiate rights attached to the preference shares so that the dividend rights are \u201ccumulative.\u201d Cumulative dividend rights mean that at the first chance your company can declare a dividend, that the dividends that your company should have paid over a period of time, it pays at once. <\/p>\n\n\n\n For example, suppose that the preferential shares\u2019 dividend rights specify payment of \u00a310 per share to be paid each quarter in dividends. However, your company has not made a profit the first two quarters. If, in the third quarter, your company is sufficiently profitable, your company would need to pay the lender \u00a330 per share in dividends.<\/p>\n<\/div>\n\n\n\n\n\n Continue reading this article below the form\n <\/i>\n<\/a>\nWhat is Debt-For-Equity?<\/h2>\n\n\n\n
Primary Considerations <\/h2>\n\n\n\n
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Discharging the Loan <\/h3>\n\n\n\n
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Process of Swapping Debt for Equity <\/h3>\n\n\n\n
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Preference Shares<\/h3>\n\n\n\n
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Redemption Rights<\/h3>\n\n\n\n
Dividends <\/h3>\n\n\n\n
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\n Cap Table Template<\/div>\n
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