October 26th, 2012 / Insight posted in

Swapping debt for equity

MC writes: We run a small company that has 100 shares in issue. We are planning to take it into a new direction and one of our business creditors wants to join us in this venture. We would therefore like to issue further shares in the company to the business creditor in settlement of an agreed amount of our debt. This will release the cash, which we would otherwise have given the creditor, for spending on the new idea. Is there anything to stop us doing this and how should we go about it?

There is nothing to stop a private limited company such as yours issuing shares in settlement of some or all of its creditors. The way to look at it is that the flow of cash has been eliminated and the money that was due to your creditor has been used with its permission to purchase some shares in the company. Remember that the number of shares you plan to issue will affect the existing shareholders because it will dilute their percentage holding in the company. Also, the price for each new share will need to be negotiated between yourself and the potential investor. This will be determined not only by the value of the existing business but also by the new business idea. It is likely that any new shares will be issued at a price that is higher than the nominal value of the shares. This premium should be shown in a share-premium account on the balance sheet and be part of the company´s capital and reserves. Essentially, you will need to do some planning to try to assess the value of the business and then decide how you are going to share the business between the existing shareholders and the new investors. Once you have carried out this exercise you will have an idea of what you are prepared to give away and at what price, and you will then be able to enter into negotiations with the investor. You should ask your professional advisers to help you through this process and to assist in calculating the value of the business. You will also need to draw up an agreement to set out the relationship between all the interested parties at the outset.