Question

Chapter 16 – In 500 words, or 2 pages double-spaced, Discuss the financial alternatives for distressed firms. Consider how these may apply to Sears (SHLD) today.

Answer 1

Financial distress in general refers to difficulty in honouring financial obligations to creditors or other stakeholders. There can be several reasons for financial distress including lack of liquidity, unforeseen economic adversities, unsustainable profits etc. Dealing with financial distress typically includes the following-

• Debt Restructuring- This is an informal process of negotiating the term of debts to the advantage of distressed entity. This includes reduction of debt, reduced interest rate, extended tenure of repayment etc.

Another way of renegotiation includes issue of equity to the creditors in exchange of partial or complete waiver of debt. This happens when company has large debts and its liquidation shall bring loss to creditors. The restructuring in this form leads to take over of entity by creditors as they end up holding substantial share of the entity.

• Debt Settlement- This is an approach where debtor and creditor agree to an amount (usually reduced) as full and final settlement of outstanding debt. The negotiation is made via Debt Settlement Company. The debtor pays amount to settlement in company in lump sum or parts. However, the settlement company withholds payments to the creditors and tries to persuade creditors to accept a lesser amount thus profiting on the difference. This method is a lose-lose situation for both debtors and creditors. In case of debtors, the credit rating gets adversely affected as although they have made the payment, they still stand as defaulters in the books of creditors. Creditors, on the other hand, may have to settle for less. Despite this, it is a method chosen over bankruptcy in various cases.

• Debt Management- This is a formal process where debtors and creditors renegotiate terms of outstanding debt. Terms typically renegotiated are tenure of debt (which is increased thus providing flexibility of repayment), instalment size, interest rate or overall reduction of debt. This might be followed by additional securitization of debt or guarantee given by a third party.