Corporate and Capital Structures:
● Balance Sheet:
Real Assets

Claims on Assets

Cash

Debt (loans, bonds, notes, etc.)

Inventory

Equity (common stock, preferred stock,
etc.)

Equipment
Plant
○ The restructuring generally occurs on the left hand side of the balance sheet.
■ E.g. Renegotiating interest payments on debt.
○ It may also occur on the right hand side, although this is ancillary, and the principal focus is still on the left hand side.
■ E.g. Divestment of irrelevant assets.
● E.g. Single project financed by a loan of 200:
Firm Value

Debt Value

Equity Value

0 0

0 50

50 0

100 100

0 150

150 0

200 200

0 250

200 50

300 200

100 350

200 150

...

...

...

X>350

200 X - 200

○ This is because equity is subordinate to debt.
○ Equity = Residual claim
● E.g. Single-project firm, to be liquidated after 1 year. Start-up costs = 10,000, of which 5,000 is debt.
○ 2,000 in a secured loan, with 5% interest rate.
○ 1,000 in senior unsecured subordinated notes, with 7.5% interest rate.
○ 2,000 in unsecured convertible debenture, with 3.5% interest rate.
○ 3 common shares. ○ Why the different interest rates?
■ Higher interest rate = Riskers; Lower interest rate = Safer.
■ Secured loan = Safest = 5% interest rate
■ Unsecured + Subordinated note = Riskiest = 7.5% interest rate
■ Convertible = Ability to share in the potential upsides by converting into equity if the company does well = Need to pay for this advantage
= 3.5% interest rate
○ How much money will be owed to each class at the end of the year?
■ 2,000 x 105% = 2,100
■ 1,000 x 107.5% = 1,075
■ 2,000 x 103.5% = 2,070
○ How much cash flow does the firm need to generate in order to be solvent?
■ 2,100 + 1,075 + 2,070 = 5,245
■ Cash flow solvency = Ability to pay one's debt as they fall due.
■ Balance sheet solvency = The nominal value of one's assets must be equal or greater than the nominal value of one's debts.
○ At what firm value does it become profitable to convert the debenture into equity?
■ After conversion = 3 + 1 = 4 shares
■ 4 x 2,070 per share = 8,280. This is because each share must be worth more than 2,070 in order for it to be profitable to convert
■ 8,280 + 2,100 + 1,075 = 11,455
PE-led LBOs: ● Re McCarthy & Stone plc:

○ They were in the business of retirement accommodation.
○ M&S plc was the entity that was publicly traded on the LSE. All outstanding shares in M&S plc was acquired by BidCo and delisted.
○ The assets of M&S plc are held by a subsidiary, M&S (D) Ltd.
○ M&S (D) Ltd holds the shares of the other subsidiaries further down in the corporate chain.
○ BidCo acted as the borrower in the acquisition financing.
■ Facilities A, B, and C: Senior term loans.
First-ranking security over certain assets, second-ranking security over other assets. Guaranteed by other group companies.
■ Facility D: Senior property revolving credit facility.
First-ranking security over assets over which ABC rank second, and second-ranking security over assets over which ABC rank first.
■ Facility E: Senior working capital revolving credit facility. Pro rata loss sharing agreement with ABC.
■ Facility F: Second lien facility.
■ Mezzanine facility.
■ Investor loan notes. These were structurally subordinated and held by an entity higher up in the corporate chain.
■ Numerous layers of debt, and complex interactions between different layers.

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