Deal-for-equity swaps

Firms basically have two sources of external finance: bank loans (‘debt’) and funds from shareholders (‘equity’). In a debt-for-equity swap, some of a firm’s debt is cancelled and lenders are given shares.

This is often a sign that a firm is in trouble - perhaps unable to make the cash needed to meet interest payments, or in breach of the debt-to-equity ratio specified by lenders and unable to raise extra capital via new bank loans, or from shareholders via a rights issue.

The swap is bad news for shareholders because it creates extra shares that they are not entitled to buy, diluting their existing holding. But the alternative, a forced liquidation initiated by lenders, often leaves shareholders with nothing at all.

MoneyWeek magazine

Latest issue:

Magazine cover
Walking out on the banks

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 3 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

The problem with the Bank of England

Fracking: Nine reasons not to get carried away

Five small-cap stocks worth a flutter

This Dutch company could help us tame floods

ScreenHunter_01 Mar. 25 09.51

Get the latest tips and investment opportunities from MoneyWeek magazine: Claim 3 FREE Issues HERE