When a business has financial trouble and considers bankruptcy, it will have two ways of finding money to pay its creditors. One of those options involves Debtor-in-Possession (DIP) financing, which can be helpful for both a business debtor and its creditors.
What is Debtor-in-possession (DIP) financing?
After filing a Chapter 11 bankruptcy, a business needs money to operate. Some companies can sustain themselves by collecting accounts receivable and using the proceeds to continue. Other debtors need to borrow money. DIP financing refers to the latter. That is, the business obtains a loan while in bankruptcy and uses the proceeds to help pay its post-filing debts. Debtors who financed their operations through a line of credit typically use this form of financing while trying to reorganize to get out of bankruptcy. The business must put up collateral, most often the same assets it pledged before filing. The existing prepetition lender often agrees to provide DIP financing under a new agreement.
In certain instances, new lenders who regularly work with chapter 11 debtors will provide the financing. These lenders include investment banks and hedge funds. In larger cases, commercial banks will offer financing.
What are the benefits of DIP financing?
One of the main benefits of this type of financing is that it allows the company to continue operating while in business bankruptcy. Without financing, a company that had traditionally relied on a line of credit may not survive. Should a bankrupt debtor shut down for any time, the chance of reorganizing decreases substantially. DIP financing also allows a business to get the money needed to pay creditors. Unless it pays post-filing obligations, its case will fail.
DIP financing can help businesses get out of bankruptcy more quickly.
If a company is considering pursuing this type of financing, the first step is to talk to its current lender. Many banks are familiar with this type of financing and may be willing to work with the company to provide the loan. After having funding in place, the debtor can develop a plan of reorganization. The plan will include projections for paying secured debt, priority creditors, such as taxes, and unsecured creditors. In addition, the plan will outline how the debtor intends to use the loan and repay it. By having financing in place, a debtor can craft a plan of reorganization and talk to creditors about supporting it.