What Is Debtor-in-Possession (DIP) Financing?

What Is Debtor-in-Possession (DIP) Financing?

Let me explain debtor-in-possession (DIP) financing directly: it's a way for companies that have filed for Chapter 11 bankruptcy protection to borrow money so they can restructure and keep operating. These DIP loans get priority over your existing debts, equity, and other claims, all in the expectation that with this fresh cash, the company can turn things around, start earning again, and pay off what it owes.

Key Takeaways

You should know that DIP financing is specifically for firms in Chapter 11 bankruptcy to keep them running. Lenders in this setup take a senior position on the firm's assets, jumping ahead of previous lenders. They offer this financing because it lets the company continue operations, reorganize, and eventually settle debts. Term loans are the go-to type now, though revolving loans were more common in the past. Expect high interest costs with this kind of financing.

Understanding Debtor-in-Possession (DIP) Financing

A debtor in possession is simply a company that's filed for Chapter 11 bankruptcy protection. If you're in that spot, you can secure financing under Section 364(c) of the U.S. Bankruptcy Code to help with reorganization. That's what we call DIP financing.

Remember, Chapter 11 is about reorganizing rather than liquidating, so this protection can be a crucial lifeline if your company needs cash to survive.

The company has to apply to the bankruptcy court for permission to borrow. The court knows you need working capital to stay afloat and pay debts, but they'll demand evidence of a strong turnaround plan.

Lenders won't just give money to a bankrupt company without checks. They'll want proof of a solid profit-generating plan and guarantees. DIP financing is typically secured by the company's assets and has priority over existing claims, so the lender gets paid first.

The court approves the financing plan to protect the business, and lender oversight needs court okay too. Once approved, you get the liquidity to operate, and creditors have a shot at recovery.

What Is the Purpose of Debtor-in-Possession (DIP) Financing?

The core purpose here is to get the company back on track, making money to grow and pay debts. It might lead to a full turnaround or just enough strength to sell assets at a better price.

Securing DIP financing signals to vendors, suppliers, and customers that the company will stay in business, keep providing services, and pay for goods during reorganization. If the lender deems it creditworthy after reviewing finances, the market likely will too.

This financing acts as a lifeline, providing capital to stay afloat and implement a turnaround plan. It's beneficial for lenders too, as liquidation might not cover all debts, but DIP could ensure full repayment.

Often, it funds operations and gradual debt payoff, giving the company a chance to exit bankruptcy and previous lenders a better shot at full recovery.

What Are the Terms of Debtor-in-Possession (DIP) Financing?

DIP financing usually kicks in at the start of bankruptcy filing, but companies often delay due to denial, wasting time since the process is lengthy.

Terms include seniority on assets if restructuring fails, plus interest costs. Once in Chapter 11 with a willing lender, you need court approval. Bankruptcy law gives lenders comfort.

Lenders get first priority on assets in liquidation, an authorized budget, market or premium interest rates, and other measures. Existing lenders typically agree, even to subordinate their liens.

The authorized budget is key—it's a forecast of receipts, expenses, cash flow, and outflows, including vendor payments, fees, seasonal variations, and capital spending. Once agreed, you settle on the loan size and structure.

DIP is often via term loans, fully funded during bankruptcy, leading to higher interest over a year or more. Previously, revolving credit was common, like a credit card, for flexibility and lower interest by managing borrowings.

What Are the Different Types of DIP Financing?

Typically, it's term loans, but alternatives include lines of credit for borrowing as needed up to a limit, or invoice factoring.

Who Typically Provides DIP Financing?

Lenders provide it—could be a bank or institution. Sometimes multiple lenders team up, or it's just one.

What Is the Difference Between DIP Financing and Exit Financing?

DIP is debt during bankruptcy, while exit financing is for companies coming out of it.

The Bottom Line

DIP financing is for firms in Chapter 11 to keep operating. Only those filing under Chapter 11 can access it, usually at the filing's start. Lenders get super-priority on assets in liquidation, work on an authorized budget, and charge higher rates via term loans.