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The Warning Signs That A Company May Need Debt Restructuring

The Warning Signs That A Company May Need Debt Restructuring

Falling Profits and Revenue Declines

One of the clearest signs a company should look at restructuring its debt is when profits and revenues start to fall on a consistent basis. This makes it harder to service existing debts and limits access to additional financing. Companies operating in competitive or cyclical industries are particularly vulnerable to economic downturns squeezing margins.

A Reddit thread discusses how revenue declines of over 20% year-over-year could indicate a need for restructuring. Even profitable companies can experience liquidity issues if cash flows tighten up. The earlier leadership starts to address excessive leverage, the better position they will be in to negotiate with creditors.

Increased Interest Expenses Are Eating Up Cash Flows

As companies take on more debt, the interest expenses associated with servicing these obligations also rise. If interest expenses grow to the point where they are consuming 20-30% or more of operating cash flows, this strains a company’s financial flexibility.

High interest costs make it harder to invest for the future, fund working capital needs, or manage unexpected expenses. A point raised on Quora is that lenders will be wary of lending additional money if interest expenses are already too high given a company’s earnings. Debt restructuring may be necessary to bring down interest costs to more sustainable levels.

Debt Ratios Are Too High Relative to Profits

Another indicator that a company should assess debt restructuring is if leverage ratios such as debt-to-EBITDA exceed 4-5x or higher. This signals a company may be overburdened with debt relative to its profit generation.

Avvo notes that lenders prefer debt-to-EBITDA ratios of 3x or less, so ratios substantially above this suggest existing debt levels are likely unsustainable. Bringing down debt through restructuring makes financial statements appear healthier and brings back lending capacity for future needs.

There Are Upcoming Debt Maturities With No Clear Way to Refinance

Companies often take on debt to make investments that will grow the business over time. This debt is structured so that maturities extend years out into the future when the investments are expected to pay off. However, if a company has large debt balances coming due in the next 12-24 months with no clear path to rolling them over, this indicates a need to restructure.

As highlighted by FindLaw, if operating trends make it unlikely a company can refinance near-term maturities, negotiating early can help minimize disruptions. This may involve pushing out maturities, securing new capital, or swapping debt for equity. Acting before maturities hit improves leverage in talks.

Vendors or Suppliers Have Tightened Payment Terms

A more subtle but telling sign a company should proactively address debt issues is if vendors and suppliers start tightening payment terms. These partners have visibility into a company’s operational health and financial statements. According to credit experts, if vendors see risk they may reduce payment terms from 30 days to “net 15” or even move to cash on delivery.

This dynamic strains cash flows further for the company. It also indicates underlying financial weaknesses visible to outside partners. Restrictive payment terms can cause a downward spiral and are a clear prompt for management to engage lenders.

Debt Holder Communication Has Intensified

Lenders and creditors typically have direct touchpoints with management about a company’s finances on a quarterly basis depending on debt agreements. However, if debt holders begin requesting interim updates, particularly on liquidity metrics or business trends, this can foreshadow debt restructuring.

According to restructuring advisors, requests for supplemental financial information often occur when creditors have observed higher risk factors in recent statements. Increased lender scrutiny is a precursor to potential waivers or amendments to debt contracts.

Key Talent Begins to Leave

A company’s talent base provides clues about financial health. If top executives, key salespeople, engineers or rising next generation leaders start to voluntarily resign, it indicates concerns about corporate stability or future viability. These employees have internal visibility and their departures signal a lack of confidence.

As noted in an HBR article, high talent churn can accelerate operational challenges. It also encourages remaining top performers to start planning their own exits. This “brain drain” makes executing a turnaround much more difficult. Sudden talent losses require urgent action around debt burdens.

Strategic Options Have Narrowed

Companies saddled with excessive leverage often lose financial and strategic flexibility. They may be forced to consider divesting prized assets, exiting higher margin businesses, or cutting critical investments simply to raise money for near term obligations.

When a company cannot pursue logical growth opportunities or make choices aligned to strategy due to liquidity constraints, it indicates a need to restructure debt. As highlighted by McKinsey, relieving debt pressures helps restore a broader set of strategic options.

Conclusion

Excessive debt can severely limit a company’s financial and competitive flexibility over time. However, the earlier management teams recognize the warning signs of unsustainable leverage, the better positioned they will be to negotiate with creditors from a place of strength. Acting decisively to restructure debt through avenues like maturity extensions, interest rate reductions, new capital sources and debt-for-equity swaps can help stabilize the business. With a healthier balance sheet, executives can focus on long-term investments to regain competitiveness.

Resources

When Should a Business Consider Debt Restructuring? – Reddit thread discussing financial warning signs

What are Examples of Debt Restructuring? – Quora examples of restructuring options

What is Debt Restructuring? – Avvo overview of restructuring debt

Restructuring Corporate Debt: An Overview – FindLaw look at the debt restructuring process

6 Warning Signs Your Business is in Financial Trouble – NAV review of early financial issues

Triggers for Debt Restructuring – AlixPartners analysis of factors prompting restructuring

Restructuring Debt, Restoring Hope – HBR on talent loss warning signs

How We Help Clients – Restructuring – McKinsey advice on increasing strategic options

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