DEBT RESTRUCTURING: DEFINITION

The debt restructuring agreement (art. 57 leg. decree 14/2019) is a means of adjustment to which the company in crisis resorts to try to reduce debt exposure and ensure the rebalancing of the financial situation.

Debt restructuring is a procedure involving an agreement whereby the original terms of a loan (rates, maturity, currency, security period) are amended to ease the burden on the debtor. The procedure is carried out for the purpose of rehabilitating the company or in order to be able to manage a liquidation on a basis agreed with the creditors and not in bankruptcy and is governed by Art. 182bis of the "Bankruptcy Law", recently introduced as part of substantial amendments to that law.

Only those public entities or privately owned companies that are in a situation of crisis or insolvency and that meet the size requirements set out in Art. 1 of the Bankruptcy Act can make use of debt restructuring.

With the restructuring agreement, it is the entrepreneur himself who continues to manage his company and - at the request of one of the parties - his assets are assisted by certain protections (such as the blocking of executive and precautionary actions), to enable him to carry out the reorganization.

DEBT RESTRUCTURING: NATURE OF THE DEBT

The object of the Business Crisis is due to the accumulation of Debt that the business is unable to repay. The type of Debt is:

• Trade Payables (to Suppliers)
• Debt to Banks (Mortgages, Financing, Loans)
• Subordinated Debt (to Shareholders)
• Tax Debt (to Inland Revenueo)

Debt Restructuring: Type of Operations

The main Debt Adjustment transactions are:

• Debt Restructuring
• Preventive Arrangement
• Excerpt
• Refinancing or Spreading
• Freezing
• Debt assignment

Specifically:

DEBT RESTRUCTURING

Debt Restructuring allows you to amend and thus ease certain conditions of the Debt Contract, such as rate, duration, cost of guarantees.

The Debtor drafts a Proposed Agreement to the Creditor(s) which they may or may not accept; the Debt remains the same but the new Terms replace the old Terms.

The Debt can only be managed in accordance with Article 1 of the Bankruptcy Law.

ARRANGEMENT WITH CREDITORS

The Arrangement with Creditors allows you to liquidate your assets to meet your debt situation.

Alternatively, it provides for the continuation and ultimate transfer of the Business to the Creditors.

It is managed only in accordance with the requirements set out in the Bankruptcy Law, Art. 1 and 160.

DEBT WRITE-OFF

A Debt Write-off provides for the fact that the Debt incurred is "written off", i.e. cancelled and loses its validity.

The Debtor can thus negotiate a new Debt with the Creditor on the most favorable terms it can bear.

It is managed only in accordance with the requirements set out in the Bankruptcy Law, Art. 1 and 160.

REFINANCING OR SPREADING

Refinancing allows you to lengthen the time it takes to repay the Debt, so the Repayment Instalment for each period is lower than the one originally agreed.

In order to administer the Refinancing, it is not necessary for the Debtor to be in a  situation of Bankruptcy, subject to the Creditor's willingness to accede to the Debtor's request for refinancing.

FREEZING

Freezing is an alternative form of Refinancing applied to the Debt Capital from the moment of the crisis, i.e. it provides that it will not be repaid for a certain period of time agreed by the parties.

During this time, the Debtor will continue to pay interest based on the outstanding debt to that point, so the Debtor gets a spread of Repayment over several years, while the Creditor gets an increase in Remuneration in the form of the increased Debt Service.

DEBT ASSIGNMENT

Debt Assignment allows the Debtor to assign all or part of his Debt to a third party who will become the new Debtor.

It provides for the fact that from the moment of the crisis the debt capital is "frozen", i.e. it is not repaid, for a certain period of time agreed by the parties.

During this time, the Debtor will continue to pay interest based on the outstanding debt up to that time.

In this way, the Debtor gets a spread of Repayment over several years, while the Creditor gets an increase in Remuneration in the form of the increased Debt Service.

"Debt Restructuring" in Italy:

"Debt Restructuring" stems from a financial problem due to the insensitivity of correct financial predictive management, so the company, at some point, begins to get into trouble, irretrievably defaults and then the problems begin.

Once the company is in trouble, the solution tends to be handled more from a legal standpoint than a financial standpoint.

The economic solution then becomes in most cases a formality, consisting of attaching an Excel spreadsheet to the legal documentation, with some accounts of very low reliability, to proceed to healthy restructuring.

The numerous failures in Italy are testimony to these two approaches:

• Insensitivity towards preventing the problem
• Management of the problem more from a legal point of view than from a financial point of view.

The skills used today to manage this type of problem are:

• The law firm, first and foremost
• The accountant's office.

The above two skills are lacking:

• financial expertise, which is not widespread in Italy and which, among other things, should act as a director for the other two skills mentioned, in order to ensure a successful debt restructuring plan.

The only tool used for Debt Restructuring, more by formality than in substance, is the Business Plan created with an Excel spreadsheet.

THE LIMITS OF EXCEL SPREADSHEET TECHNOLOGY FOR DEBT RESTRUCTURING

Any Debt Restructuring plan must start with economic and financial advice, because it is necessary to transform "bad" Debt into "healthy" Debt intended to reorganize, restructure and relaunch the company in order to return to having the cash flow necessary to repay the debt.

For a correct approach to the problem, it is therefore necessary to reproduce the "Corporate Business Model" in a projection equal to the expected repayment period of the debt, which must have:

• the company's balance sheet for the previous period, in line
• the company's Budget of operating costs and revenues forecast for the period considered, with details of the relevant VAT rates, payment and collection days
• fiscal policy
• macroeconomic variables
• dividend policy
• the relative risks that will act on the various quantities defined in the BP in terms of probability and relative deviation in % or absolute value.

On the Business Plan, thus defined, strategies will then be made to define:

• the ability of the model to repay what % share of the debt
• simulation on the impact model of the different strategies (restructuring, write-off, freezing, etc.) in order to verify their effectiveness
• defining the balance between capital and debt contribution for tax optimization
• at the same time structuring the new business model for the reorganization and relaunch of the company.

Unfortunately, the average reliability of any Business Plan created with Excel sheet technology, regardless of the skill of the analyst who made it, is on average 15-20%!

Let's see the reasons in detail, discovering that, in addition to the lack of Reliability, there is also a lack of Opportunity and Profitability for Business Plans made with Excel, which greatly limit the possibilities of debt restructuring and a corporate revival.

LACK OF RELIABILITY

The average reliability of a "Business Plan" created with Excel sheet technology, regardless of the skill of the analyst who processes it, was measured on a large number of BPs processed, created for "Debt Restructuring" operations and was in the average order of 15-20%.

An approximation of about 20%, in the best case scenario, means that each result obtained has a reliability of 20% or, in other words, has a margin of error equal to its complement, i.e. 80%. This means, for example, that a Cash Flow value of €1,000,000, calculated in this way, ranges from a value of €1,000,000+/- 800,000, i.e. €200,000 to €1,800,000. 

This type of approximation highlights a problem of reliability of the result obtained, but even more of precariousness to take the entrepreneurial decisions that have a financial economic impact on the Restructuring Plan.

Let's look at the structural reasons for the inadequacy of the "Business Plan" created with Excel Sheet technology for reliable financial economic representation of a Business Model, of a Debt Restructuring Plan:

Annual Analysis:

of Business Plans developed with Excel, for a period ranging between 5 and 20 years, is one of the most striking causes of unreliability, for these reasons:

Cash that is always positive, on an annual basis, may, in fact, turn out to be negative for most months with the need to cover it with Bank Lines or a capital increase. NPV and IRR and other values are unreliable. 

An annual-based cash flow prevents visualization of tax payments, dividends in specific months, preventing evidence of critical liquidity issues, which become the prerequisite for having a reliable Predictive Model in Real Economy on which to make correct decisions.

Incorrect calculation of working capital. In a recent analysis we found a working capital of € 700,000 against an investment of € 3Ml.

LACK OF A SYSTEMATIC APPROACH:

due to the inability of Excel spreadsheet technology to take into account all the variables inherent in a given context such as, for example:

The VAT rates associated with each variable that enters the model.

Payment/collection days 

The different tax rates

Risk variables, not taken into due consideration.

VAT MANAGEMENT PROBLEM:

is handled incorrectly or insufficiently in most "Debt Restructuring" Business Plans.

In a Debt Restructuring operation in which VAT was omitted because, in order to simplify the model, it was considered a clearing entry

In a Debt Restructuring case, horizontal VAT compensation was not considered with negative consequences on the restructuring plan.

WORKING CAPITAL PROBLEM (DUE TO DIFFERENCES BETWEEN PAYMENT AND COLLECTION DAYS):

in most cases the Business Model is ignored not for competence problems, but due to the impossibility of managing it on an annual and not monthly basis.

In a Debt Restructuring project the amount of Working Capital was completely neglected.

PROBLEM OF THE LACK OF CERTIFICATION OF THE ALGORITHMS USED:

due to the lack of reference to sources declaring their correctness, which is an important element that every Investor/Entrepreneur should require. Certification is required for wine, for oil, but not for BPs, which decide on the analysis of investments or strategies worth millions of euros.

In a Debt Restructuring Project the investor asked which algorithms were used and by whom they were certified. Of course the Algorithms were not certified, because when are they ever certified! Obviously the acquisition, which was supposed to be the result, was not finalised.

COMPLEXITY-RELATED ERROR PROBLEM:

due to the fact that the more complete you make the BP model on the Excel sheet, the more the probability of error (of formula, of not connected cell, of calculation, etc.) increases, making the results unreliable.

THEREFORE, THE "EXCEL SPREADSHEET", FOR CREATING BUSINESS PLANS FOR "DEBT RESTRUCTURING" OPERATIONS, IS THE FIRST RISK, EVALUATED TO BE ABOUT 80-85%.

Therefore, the "Excel Sheet", in order to create the Business Plans for "Debt Restructuring" operations, is the first risk, evaluated in the average order of 80-85%.

LACK OF OPPORTUNITY

The possibility to manage the different cases that a Business Model can offer in a flexible manner, is very limited with  Excel spreadsheet technology, as this technology does allow models to be developed that can thoroughly simulate the different economic and financial aspects of reality. The assumption that you can do everything with Excel is simply not true!

In fact, reproducing the various assumptions on an Excel spreadsheet, means recutomising the model every time, with consequent loss of time, rendering operativity impossible and obviously the principle that it is always possible to do so is not applicable, as it goes against the principle of unmanageability due to excessive complexity.

However, not managing them means not being able to translate possible solutions into reliable financial economic data to find the best solution.

What does this limit mean for the investor? It means not finding the optimal solution in a Corporate Restructuring, Debt Restructuring operation.

Let's look at the structural reasons for the inadequacy of the Excel Spreadsheet due to the limited Opportunities it can offer in managing the various "Debt Restructuring" operations:

DIFFICULTY/IMPOSSIBILITY IN BREAKING DOWN A BUSINESS MODEL INTO ITS BUSINESS UNITS

due to the complexity that would be induced in the Excel model to handle them. In fact, the Business Unit represents the minimum unit of analysis with its investments, costs and operating revenues, used to break down the company model into its operating divisions in order to allow the entrepreneur to decide priorities in investments, on which business units to focus attention and operate.

In a "Debt Restructuring" operation, it is very useful to seek the divestment of those activities that eat away margins or lead to higher costs in order to leave room for Business Units with higher margins.

DIFFICULTY/IMPOSSIBILITY OF ANALYSING A BUSINESS MODEL IN ITS VARIOUS SCENARIOS

based on the different assumptions, having to work on the formulas which is time consuming and increases the possibility of errors.

In "Debt Restructuring" projects, it becomes fundamental to evaluate the scenarios deduced from the assumption of various hypotheses. It also becomes an added value to be able to give an immediate answer to the Bank or to an investor on the economic and financial consequences of an assumption.

LIMIT OF MANAGING SEVERAL DEBT LINES AT THE SAME TIME

In a complex Corporate Restructuring project, the Excel model was completely inadequate for the optimal restructuring of the Debt divided into 8 Debt Lines with different conditions for each and different trigger criteria.

DELEGATION DIFFICULTIES

due to the fact that in the BP created using spreadsheets, the data are wired with formulas and therefore only the person who has drawn up the BP can work on it with all imaginable limits can  and cannot delegate to other departments.

In Debt Restructuring projects where many different solutions need to be evaluated, having the possibility to delegate the data upload is an added value in terms of time and the possibility to explore the best solutions.

LACK OF PROFITABILITY

The Business Plan (BP) of a "Debt Restructuring" plan elaborated with a spreadsheet - besides having a reliability of 15-20% and therefore not significant for seriously analysing a financial operation of hundreds/millions of euro - of great impact for the Entrepreneur, presents this recurring issue:

OVERESTIMATION OF THE SOURCES TO COVER THE RESTRUCTURING (EQUITY, BANK LINES, SHAREHOLDER FINANCING)

because it does not allow a financial optimization of cash flows allowed instead by the decomposition of the Corporate Model into Business Units, by the management of flows on a monthly basis and by the management of self-financing, too complex to reproduce with Excel technology. This causes the Entrepreneur to waste useful capital that he could use in other ventures and also reduces the Profitability of the Company or the financial operation.

A Debt Restructuring Project for about € 12 million, handled with a classic BP on Excel sheet, required a minimum amount of € 7 million, but when it was examined instead with "Finance Atena", with the same boundary conditions and banking conditions, it required € 5 million.

THE SUSTAINABILITY OF THE CORPORATE MODEL BECOMES INCREASINGLY CRITICAL

because it does not take into account all the financial variables involved which are, among other things, displayed in an annual analysis and not monthly as it should be. The reasons for these results are mainly due to the fact that a predictive financial economic analysis is a very complex analysis and it is inadequate to try to translate it on an Excel spreadsheet due to its structural limitations, due to the problem posed.

Sustainability on an annual basis in most cases is critical because it does not take into account cash flows on a month basis, creating unrealistic Reliability and, ignoring the necessary hedges, leads to an underestimation of the debt.

MORE EXPENSIVE RESTRUCTURING PLANS

due to Excel technology that cannot consider all the variables in progress, so it always tends up costing the entrepreneur more, even ending up jeopardising the same plan that is disregarded.

A Debt Restructuring Project, against an initial budgeted debt service costs of €3 million, turned out to be €5 million.