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Special Situations
Businesses whose capital structure has become unsustainable.
Special situations refer to situations where the capital structure of an otherwise healthy business has become unsustainable. They tend to arise because of a cyclical under-performance combined with an upcoming debt maturity and are often characterised by complicated group structures or unusual or difficult-to-value collateral.
Typical scenarios
- Debt under pressure from excessive leverage, a covenant breach or market perception
- An unwillingness of a lender to continue financing beyond maturity
- Removal of trade credit insurance cover so that suppliers demand payment in advance
- Financing alongside a restructuring programme that is paid off using a contemplated divestiture
- Financing of distressed acquisitions
- Recapitalisation of a business that has insufficient equity capital
What we look for
- A sound business with a stretched capital structure
- A clear exit or repayment strategy: refinancing, selling off a division, or sale of the entire recovered business
- Collateral that will protect the investment in a downside scenario
Instruments
Senior secured and asset-based loans (ABLs), bridge financings, mezzanine, HoldCo and PIK (payment-in-kind) loans and other forms of hybrid capital such as preferred equity, perpetual loans, convertible loans and loans with warrants.
Questions
01What are special situations in finance?
Special situations occur when a business requires financing due to an event that occurred outside its ordinary business activities. Examples include cyclical underperformance of the business combined with an approaching debt maturity or an anticipated covenant breach, an acquisition or an ownership change. These companies usually have a viable business but a financing or capital structure that does not suit their current situation or business plans. The financing that they need to be able to solve the situation likely needs to be provided faster and on more flexible terms than an ordinary loan from a bank.
02How does the concept of special situations differ from distressed debt?
Distressed debt refers to debt of a company that is either in default or close to default and involves buying the debt at a discount to its par value or principal amount. These businesses generally require a liquidity injection and often involve the introduction of equity or hybrid capital to help the business get out of financial distress (e.g. via a debt-for-equity swap). Special situations are a broader concept and also cover companies that are not in financial distress.
03In what circumstances does a healthy business require special situation financing?
Most of the time when a business downturn coincides with an upcoming debt maturity. The business downturn leads to lower earnings, higher leverage and reluctance of existing bank lenders to amend and/or extend their existing financings despite the viability of the business. This situation may also be caused by (anticipated) breaches of covenants, cancellation of trade credit insurance coverage and/or disposals that will take some time to execute.