What is debtor-in-possession (DIP) financing?
Debtor-in-possession (DIP) financing is a special type of financing for bankrupt businesses. Only companies that have filed for Chapter 11 bankruptcy protection are allowed to access DIP financing, which typically occurs at the start of a filing. DIP financing is used to facilitate the reorganization of a debtor-in-possession (the status of a business that has filed for bankruptcy) by allowing it to raise capital to fund its operations as its bankruptcy filing follows. his courses. DIP financing is unique from other financing methods in that it generally takes priority over existing debt, equity, and other claims.
Key points to remember
- Debtor-in-Possession (DIP) financing is financing for businesses in Chapter 11 bankruptcy that allows them to continue operating.
- DIP financing lenders occupy a prominent position on the liens of business assets, ahead of previous lenders.
- Lenders allow DIP financing because it allows a business to continue operations, reorganize, and eventually pay off debts.
- Term loans are the most common type of financing, which used to be revolving loans.
Understanding debtor-in-possession (DIP) financing
Since Chapter 11 favors business reorganization rather than liquidation, filing for protection can provide a vital lifeline to struggling businesses in need of financing. In debtor-in-possession (DIP) financing, the court must approve the financing plan consistent with the protection given to the business. Lender monitoring of the loan is also subject to court approval and protection. If the financing is approved, the business will have the cash it needs to continue operating.
When a business is able to obtain DIP financing, it lets vendors, suppliers, and customers know that the debtor will be able to remain in business, provide services, and make payments for goods and services while it reorganizes. If the lender has concluded that the business is worthy of credit after reviewing its finances, it stands to reason that the market will come to the same conclusion.
During the Great Recession, two bankrupt U.S. automakers, General Motors and Chrysler, were recipients of debtor-in-possession (DIP) financing.
Obtaining debtor-in-possession (DIP) financing
DIP financing typically occurs early in the bankruptcy filing process, but often troubled businesses that can benefit from court protection will delay filing because they fail to accept the reality of their situation. Such indecision and delay can waste valuable time, as the DIP funding process tends to be lengthy.
Once a business enters Chapter 11 bankruptcy and finds a willing lender, it must obtain bankruptcy court approval. Providing a loan under bankruptcy law provides much-needed comfort to the lender to provide financing to a business in financial difficulty. DIP financing lenders have priority over assets in the event of a business liquidation, an authorized budget, a market or premium interest rate, and any additional comfort measures the court or lender deems warrant. ‘inclusion. Current lenders generally have to agree to terms, particularly overriding a lien on assets.
The approved budget is an important aspect of DIP funding. The “DIP budget” may include a forecast of the company’s revenues, expenses, net cash flows and outflows for rolling periods. He must also take into account the forecast schedule of payments to suppliers, professional fees, seasonal variations in his income and any capital outlay. Once the DIP budget is agreed upon, both parties will agree on the size and structure of the credit facility or loan. This is only part of the negotiations and legwork required to obtain DIP funding.
Types of loans
DIP financing is often provided through term loans. These loans are fully funded throughout the bankruptcy process, which means higher interest charges for the borrower. Previously, revolving credit facilities were the most widely used method, which allowed a borrower to draw on the loan and repay as needed; like a credit card. This allows for greater flexibility and therefore the possibility of lowering interest charges, as a borrower can actively manage the loan amount borrowed.