What is ‘Debtor-in-Possession Financing (DIP Financing)’
Debtor-in-possession financing (DIP financing) is a special kind of financing meant for companies that are financially distressed and in bankruptcy. Only companies that have filed for bankruptcy protection under Chapter 11 in the United States and the CCAA in Canada can utilize it, which usually happens at the start of a filing. It is used to facilitate the reorganization of a debtor-in-possession (the status of a company that has filed for bankruptcy) by allowing it to raise capital to fund its operations as its bankruptcy case runs its course. DIP financing is unique from other financing methods in that it usually has priority over existing debt, equity and other claims.
Breaking Down ‘Debtor-in-Possession Financing (DIP Financing)’
Since Chapter 11 favors corporate reorganization over liquidation, filing for protection can offer distressed companies in need of financing a needed lifeline. In a debtor-in-possession financing the court must approve the financing plan consistent to the protection granted to the business. Oversight of the loan by the lender is also subject to the court’s approval and protection. If the financing is approved the business will have the liquidity it needs to keep operating.
When a company is able to secure debtor-in-possession financing it lets vendors, suppliers and customers know that the debtor will be able to remain in business, provide services and make payments for goods and services during its reorganization. If lender has found that the company is worthy of credit after examining its finances it stands to reason that the marketplace will come to the same conclusion.
As part of the Great Recession, two bankrupt U.S. automakers — General Motors and Chrysler — were the beneficiaries of debtor-in-possession financing.
Debtor-in-Possession Financing: Key Methods
DIP financing is frequently provided via term loans. Such loans are fully funded throughout the bankruptcy process which means higher interest costs for the borrower. Formerly, revolving credit facilities were the most utilized method — a favorable arrangement for the borrower, as it offers good flexibility and the option of reducing interest expenses by actively managing borrowings to minimize funded amounts.
Debtor-in-Possession Financing Process
As noted, DIP financing usually occurs at the beginning of the bankruptcy filing process. But often, struggling companies that may benefit from court protection will delay filing out of failure to accept the reality of their situation. Such indecision and delay can waste precious time, as the DIP financing process tends to be lengthy. One step in the process is that lenders and the debtor must agree to a “DIP budget,” which can include a forecast of the company’s receipts, expenses, net cash flow and outflows for rolling 13-week periods. It must also factor in forecasting the timing of payments to vendors, professional fees, seasonal variations in its receipts and any capital outlays. Once the DIP budget is agreed upon, both parties will agree on the size and structure of the credit facility or loan. This is just a part of the negotiations and legwork necessary to secure DIP financing.