Debt to Equity conversion, please explain someone.

[jarv]

I spent some time researching debt to equity rates and conversion. It seems quite straight forward to understand but I can't get my head around the important bit.

Fulham has 200 mill debt which is BAD.
MAF converts the debt to equity which is GOOD becasue the business is much more healthy on paper.

Buyer comes in and offers 200 mill to MAF, so he gets his money back The buyer is getting a healthy business but has had to pay 200 mill for it. So buyer is in the hole and we hope he has a good sustainable business plan!!!

If the debt had stayed as debt, then the buyer would have to buy the debt but that was to MAF. This is the bit I can't get my head around, surely, either way, MAF gets his money back because the buyer would have to borrow money to buy the debt, wouldn't he?  :49: :58: (or she in this equal world).

Any accountants on here who can explain it? (preferably in pictures) :005:

One thing, this is a lot of money and no buyer would part with that lind of money unless they had a plan or the name of the team is BLACKBURN or QPR. :005:

[Riverside]

You are assuming that the price paid was enough to have paid off all the debt in one go .
If the price was less or if the payment is in instalments . Equity is better - for the buyer .

[Fulham1959]

If it was still debt, he could have bought Fulham for £1.00 on the understanding that he immediately repaid the debt of £200M.

[jarv]

yes, that is my point. It amounts to the same thing doesn't it? Same result.

[Fulham1959]

I think so, but I'm no expert on these matters !

[Apprentice to the Maestro]

Is the debt to equity anything to do with the sale? I thought it was to do with the financial rules and that clubs with debt would not be eligible for Europe for example.

[MikeR]

If the debt was greater than the market value of the club then MAF would never have been able to sell it - sort of like a homeowner trying to get someone to take over his mortgage when he's underwater. Someone has to take the loss. In this case, MAF was both owner and bank, so the "bank" may have taken a loss so that the "owner" could sell.

[Brown@FFC]

When you buy a club, you buy the debt that is there. You can pay it off straight away, or do it over time.

[ron]

Smoke, mirrors, an imaginative accountant, the Cayman Islands etc. all have their part to play in dealings like these.

[YankeeJim]

I think its a bit like riding a Harley: "If you have to ask, you wouldn't understand."

[bigglesfc]

Ok here goes, this is my second accounting post in two days.

I am a forensic accountant. 

I am not totally sure what the complete corporate structure of FFC was but I will try to explain it simply.

If FFC was owned by a company, the company borrowed funds from MAF over a period of time to run the club, buy players etc, which built up debt to Maf, that is the company owed money to MAF.  It got to the point over a period of time that the company that owned FFC owed MAF 200M.  The debt. 

MAF decides that he does not want the company in debt so he converts his 200M to shares in the company (equity).  The company becomes debt free.  Now instead of owning 1 share in the company MAF may own 200M share, or two or whatever.  The number of shares is not really important, as the company is still worth the same regardless of the number of issued shares.  MAF is now paid a dividend on his shareholding, not interest on the debt.   Debt to equity swap.

If Mr KHAN, or whoever else wants to buy FFC, presumably he would buy the company that owned FFC, thereby owning FFC. (company ownership of assets can be another topic if you like).  He could do it three ways, either have the company owning FFC borrow money, thereby creating a debt to a bank, which interest would be paid on, lend money himself to the company creating a debt to himself, or buy shares in the company thereby becoming a shareholder.  If he had the cash he would probably do either of the last two.  He still gets a return either way, either in the form of an interest payment if it is debt, or a dividend on the profits if it is equity.  The thing is that interest will be paid regardless of profit (see yesterday's post re profit of a business).  But in the US investments are taxed diferently from incomes, so if there is a US investor on the post who may explain this go ahead.  My understanding is that investment income aka dividends are taxed at 15%, so this may be the most tax advantagous way for a US investor to structure the deal, if FFC was going to be profitable in the future.

Of course Mr Khan could separate the company from FFc and have FFC owned by an existing Khan enterprise or some other corporate structure, but I don't know the exact details of the takeover. 

That is a debt to equity swap.  Let me know if it makes sense.  I can run other accounting related topics if you are still awake.   

[Bradstow]

Share Capital of a company is not regarded as a debt, it simply represents the capital invested by the owners of the shares. It is not repayable except on a liquidation of the company or some other re-organisation of the company's structure. It carries no right to interest and ranks last in the list of priority for repayment on a liquidation. A shareholder cannot sue the company for the repayment of his investment. A simple loan to the company ranks as a liability and the terms of the loan decide how and when it has to be repaid and what interest it bears. The provider of the loan can sue the company for repayment of his loan.

What FFC did effectively was to repay the loan to MAF and at the same time MAF bought shares in FFC. In one simple move the possibility of the club being sued for repayment was completely removed. It also crystallized MAF's capital gains tax position. The cost of his investment in FFC was now totally represented by the cost of the thing he could sell - his shareholding - rather than a token cost of the shares plus a large loan.

[Denver Fulham]

It also can matter a lot more in situations where there's more than one shareholder. A conversion of debt to equity could significantly change the percentage ownership in an entity, possibly to a controlling level. Or where the debt is at an abnormally high interest rate that's impacting annual cash flow because of the high repayment costs.

In Mo's case, it appears to be more bookkeeping and/or tax purposes, especially as the debt was at 0% interest.

[Holders]

That was most helpful, Biggles, Bradstow and Denver. Thank you.

I wonder if Keegan still has the shares in the club that Mo gave him.

[jarv]

yes, most helpful. I feel enlightened (and pleased I never considered a career in accountancy).