Debt-to-equity swaps: convert a creditor into a shareholder instead of paying all the debt in cash

A debt-to-equity swap replaces some or all of a company's debt with newly issued shares. It is often used in restructurings when the borrower cannot repay on the original terms but the creditor believes the business has more value as a continuing company than through enforcement or insolvency.

The creditor accepts shares in exchange for releasing debt

HMRC describes a debt-equity swap as a situation where a creditor takes shares in the borrower instead of repayment and discharges the corresponding liability. The shares can be worth less than the face value of the debt, particularly in a distressed restructuring.

The transaction reduces cash debt service and leverage, but it also changes ownership. Existing shareholders are diluted and the former lender can become a material voting or preference shareholder.

Define exactly how much debt is released

The restructuring agreement should state principal, accrued interest and fees being exchanged, and what debt remains outstanding afterwards. A partial swap can leave a smaller loan alongside the new shares.

Do not rely on one accounting journal to create the transaction. Creditor release and share allotment need legal documents and board or shareholder approvals as required.

Share value and conversion price drive dilution

If £5 million of debt converts at a £10 million equity value, the creditor can receive a large percentage of the restructured company. Different share classes and preference rights can alter the economic ownership further.

Obtain valuation advice and model the post-swap cap table. Existing owners should know whether they retain control and what rights the creditor receives.

Debt release and connected-company rules need specialist tax analysis

HMRC's loan-relationship guidance contains specific treatment for debt-equity swaps and connected companies. The tax result can differ depending on the relationship between creditor and borrower before and after the swap.

Use current advice before finalising terms. A restructuring designed for cash survival should not create an avoidable tax liability because the legal form was chosen casually.

Other lenders and shareholders can have consent rights

Senior facilities can restrict new share issues, debt releases or changes of control. Existing investors can also have pre-emption or class-consent rights.

Map every consent before signing. A creditor can agree commercially to convert and still be unable to complete until the wider capital structure approves the change.

Close the debt and issue the shares cleanly

After completion, update the debt register, accrued-interest schedule, share register, cap table and Companies House filings. Any security released as part of the swap should also be documented.

The bank balance may not move at all on the conversion date, which makes legal and accounting evidence especially important. The transaction changes the balance sheet even without a cash transfer.

Worked example: a lender is owed £3 million principal plus £200,000 interest and agrees to convert £2 million into preference shares while leaving £1.2 million as a restructured term loan. The company reduces scheduled cash repayment but gives the lender ownership rights and still retains some debt.

Use a post-restructuring cash forecast. A swap can reduce debt service dramatically, but the business still needs enough working capital to reach profitability after the balance-sheet repair.

Communicate the new ownership structure to banks, insurers and other counterparties where required. A major creditor becoming a shareholder can affect change-of-control provisions or KYC records even if no one buys shares for cash.

Build a pre- and post-swap capital table that includes ordinary shares, preference shares, options and any remaining debt. The percentage issued to the creditor can look modest when calculated against today's shares but become much larger after preference rights or conversion instruments are included. Directors should approve the fully diluted outcome rather than one headline percentage.

Worked example: a company owes a lender £6 million and cannot refinance. The lender agrees to convert £4 million into shares and leave £2 million as a five-year loan. The annual cash interest and principal burden falls sharply, but the creditor becomes a significant owner with board and information rights. The restructuring trades cash pressure for dilution and governance change.

Review how existing security is treated. If part of the debt remains, some charges may stay in place; if debt is fully discharged, releases or satisfactions may need filing. Leaving obsolete security on the public register can obstruct later financing even after the creditor becomes a shareholder.

Consider employee and minority-shareholder effects. A large creditor conversion can change voting control and future option values even where the business survives. The restructuring communication should explain the post-swap ownership clearly enough that remaining shareholders understand the dilution.