Staying Afloat During Bankruptcy: A Guide to DIP Financing

Staying Afloat During Bankruptcy with DIP Financing

If your business is struggling, you may be considering or have filed for bankruptcy. Filing for Chapter 11, or “reorganization” bankruptcy, allows you to work to repay creditors.

But this repayment of your existing obligations may be difficult without an injection of capital into your business. Additional cash would allow you to better fund operations while you are working through a bankruptcy plan. This is where DIP financing can help.

What Is DIP Financing?

DIP – or “debtor-in-possession” – financing is available to companies that have filed for Chapter 11 bankruptcy. The term refers to the fact that the company remains in control or “in possession” of the business. It allows the company to obtain loans to fund operations while the bankruptcy runs its course.

Lenders allow these loans because it will enable the company to reorganize as needed, continue operations, and pay off its debts. DIP financing loans take priority over existing debt, equity, and other claims. Reorganization is more favorable compared to liquidation. Another alternative is that the company would improve enough to sell to a buyer.

Lenders will make DIP loans when they believe that the company can turn itself around with access to additional money. The bankruptcy court must approve the financing plan. If you obtain DIP financing, existing vendors, supplies, and customers must be notified.

How DIP Financing Can Help

Rather than be crippled during the bankruptcy process, DIP financing can allow you to make necessary changes to your business. By funding operations, you will be able to more easily do things like:

  • Make payroll
  • Fund operations
  • Restructure your balance sheet

DIP financing can also help to reassure the management and employees of your organization. Knowing that there are additional funds available shows that there is a way forward. 

When Should You Obtain DIP Financing?

You will be working with a bankruptcy attorney through the process, but you will also need to find a lender to obtain DIP financing.

The earlier you can obtain DIP financing in the bankruptcy process, the better. Because the court has to approve the financing, it can be take some time. Delaying access to funds may only hurt your business more.

There are some things to consider when obtaining DIP financing.

Your current lenders must agree to the terms. Because DIP financing will take seniority in liens, you will need to work with any existing creditors. They will essentially take a “backseat” to the new loan.

An authorized budget will need to be prepared. This will show the use of the funds and forecast cash flow. It will also identify the timing and payments to your creditors.

Different types of loans are available. Most common are term loans but accounts receivable factoring is also sometimes used. A lender can help you talk through the options and what makes the most sense for your business.

Steps in DIP Financing

You will need to take several steps to obtain DIP financing during the bankruptcy process.

1. Determine How Much Money You Will Need

You may know that your business would benefit from access to additional cash during bankruptcy, but you will need to identify how the money will be used. This will require some legwork. Because the court and creditors must approve DIP financing, the first step in determining the amount needed will require you to think about the uses of the money and the budget.

Is the money to cover a cash flow shortage until operations improve? Is it to purchase equipment or make another investment that will improve the business? Make a plan with your lender so that it can be presented to the court and other creditors.

2. Approval of Strategy

When you have found a lender willing to work with you for DIP financing, the next step is to obtain the necessary approvals.

If the loan includes collateral on a secured basis, other creditors will need to consent to the new loan. The bankruptcy court must also be convinced that existing creditors are adequately protected. Creditors are willing to do this if they feel that the loan will further the borrower’s ability to repay.

Benchmarks will be set by those who are approving the strategy. As the borrower, you will be expected to meet those benchmarks. This may feel challenging, so ensure that you seek proper guidance on how to meet those benchmarks.

3. Funding for Operations/Restructuring Assets

After approval and funding of your loan, your business can begin to use the funds for equipment or other operational expenses. Restructuring of other assets may occur as part of the financing plan.

This part occurs throughout the course of the bankruptcy. If the financing received is a term loan, it may cover several years as your company looks to improve.  

The financing can allow your business to return to its original operations. Even better, you may be able to grow and thrive because of the access to additional funds.

4. Exit Financing

Once the DIP financing is paid off, your business can move forward to the final stage of the process.

At the end of the bankruptcy, your company may need exit financing. DIP financing occurs while the company is going through bankruptcy. 

Exit financing occurs at the end of the process and is a post-bankruptcy funding package. This is known as a “DIP rollover.”

The eventual goal is to come out of bankruptcy with a stronger balance sheet and a plan to move forward.

Finding a Lender for DIP Financing

You may not have been aware that DIP financing is an option in bankruptcy. By talking to a lender with experience in DIP financing, you can find a solution to help your business. You will want to work with a lender that can help borrowers identify and meet their DIP goals.

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