When businesses enter periods of financial distress and are no longer going concerns, with limited time before all sources of cash and liquidity are exhausted, turnaround capital often emerges as the lifeline needed to restore stability and growth. This crucial form of financing involves injecting funds into distressed companies to enable strategic transformations and operational revitalisations. But what exactly does turnaround capital entail, and what do equity investors seek in return for their high-risk investments?
What is Turnaround Capital?
Turnaround capital refers to the funds deployed to help struggling companies overcome financial distress. This capital is pivotal in implementing restructuring plans, repaying or restructuring debt, enhancing cash flow, and addressing inefficiencies within the organisation. The ultimate aim is to guide the company back to profitability and long-term viability.
Equity vs. Debt in Turnaround Capital
Investors in turnaround situations can provide capital in the form of either equity or debt, each with its own set of advantages and strategic implications.
Equity Investments:
Common Equity: Investors provide cash in exchange for shares, gaining ownership and often significant control over the company. This type of investment does not add to the company’s debt burden, which can be crucial for heavily indebted firms.
Preferred Equity: This form of equity offers investors dividends and priority over common equity holders in the event of liquidation. It strikes a balance between debt and equity, offering security and potential returns.
Debt Investments:
Senior Debt: Secured loans that take priority over other debts in case of liquidation. While safer for the lender, they come with strict terms and covenants.
Mezzanine Debt: A hybrid of debt and equity, mezzanine financing is typically unsecured and subordinate to senior debt but senior to common equity. It often includes an option to convert to equity, providing potential upside if the turnaround succeeds.
Debtor-in-Possession (DIP) Financing: In bankruptcy scenarios, DIP financing allows a company to secure new capital while undergoing reorganisation, with these new loans often receiving priority over existing debts.
The Importance of Equity Control in Turnaround Investments
Equity investors in turnaround situations frequently seek a significant, if not majority, stake in the company to offset the high risk associated with their investment. The extent of control required can vary based on several factors:
Degree of Control Needed: Investors may require a majority stake to ensure they have the authority to implement critical changes in management or strategy necessary for the turnaround.
Risk and Reward Balance: A majority stake aligns the high risk with the potential for substantial returns if the turnaround is successful.
Negotiation and Existing Ownership: The final ownership percentage is often a product of negotiations with existing shareholders and the company's distress level.
Investment Size: The amount of capital needed can naturally lead to a majority stake, particularly if the company's valuation has plummeted due to financial difficulties.
However, majority control is not always a necessity. In some cases, investors may opt for a significant minority stake, provided they can still exert considerable influence through board seats, veto rights, or other governance mechanisms. This approach can be more acceptable to existing shareholders while still allowing investors to drive necessary changes.
Q&A: Key Financial Terms
Q: What is equity investment?
A: Equity investment involves injecting capital into a company in exchange for ownership shares, which can include both common and preferred equity.
Q: What is senior debt?
A: Senior debt is a type of loan that takes priority over other unsecured or junior debts in case of liquidation, offering lower risk to lenders but often coming with stricter terms.
Q: What is mezzanine debt?
A: Mezzanine debt is a hybrid financing option combining elements of debt and equity. It is subordinate to senior debt but senior to equity and often includes an option to convert to equity.
Q: What is debtor-in-possession (DIP) financing?
A: DIP financing refers to new capital provided to a company undergoing bankruptcy reorganisation, often granted priority over existing debts to facilitate the restructuring process.
Q: What is preferred equity?
A: Preferred equity is a form of equity that offers investors dividends and priority over common equity holders in liquidation events, providing a balance between security and potential returns.
Enquiries
For further information, please contact info@langdoncap.com
About the author
Sabbir Rahman is Managing Director of Langdon Capital. He has held prior roles with Morgan Stanley, Lazard and Barclays Investment Bank. He has executed over £60 billion in notional value of debt, equity, M&A and derivatives transactions with global corporates, private equity funds and financial sponsor groups.
About Langdon Capital
Langdon Capital assists SMEs and mid-market companies with capital raising, M&A and disposals up to £250m in transaction size; and innovative, high-growth companies with >£1m in annual revenue and >30% in annual revenue growth raise debt or equity, at Series A and later funding rounds, from a network of alternative investors spanning private equity firms, venture capital funds, corporate VC arms, family offices, venture debt funds, private credit funds, real estate funds and hedge funds.
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