Possessing wealth is not enough, but you need to invest it in proper manner if you wish to enjoy it for a long time. Most people go for some kind of investment to secure their money. People who are willing to take risks put their hard-earned money at stake and invest in high risk investment options like stock, mutual funds, etc. Those who wish to play it safe go for low return, yet secure options like banks. No matter what investment option you choose, it is imperative that you think a hundreds times before investing your money in it. You simply cannot afford to allow your investment to shrink due to whims of economy. Distressed debt investing is yet another investment option for the enterprising folks willing to take risks.
What is Distressed Debt Investing
Distressed debt refers to the bonds of the company that is not doing well financially. When the company faces a critical financial trouble it can choose to sell its bonds (debts) to new buyers. Such company might have already filed for bankruptcy or heading for one. Thus, distressed debt investing simply means investing in the bonds of a failing company. The company sells its bonds to its new buyers at dirt cheap prices. This is often the last resort to recover from a financial turmoil. The new buyers have the required resources to buy the bonds of the failing companies. Mostly, these buyers are the financial entities such as mutual funds, private equity firms, brokerage firms, hedge funds and specialized debt funds. These entities have their own criteria which enables them to invest in the right companies. Some of these parameters are as follows:
- Checking if the company has legal problems.
- Checking if the company has overextended debts.
- Checking if the company has operational issues.
- Checking if the company is underperforming.
- Checking if the company has good potential for recovering in the future.
Returns in this investment option are usually high, if you invest in the right company. Buyers are more interested in buying the debts of the company than the equity shares. This is because in an event of liquidation, debt owners are given priority over equity holders, meaning debts are liquidated before equity. During the liquidation of the debts, the buyers often get a good return on investment as the debt liquidates at a much higher price than its initial selling price. Thus, the buyers make much profit upon their initial investment. If the company survives, then the buyers have a greater stake in the restructuring and reorganizing of the company. Mergers, takeovers and restructuring are some of the ways of resurrecting a failing company. If the company does well after reorganization, the investors can still claim a profit share.
Risks
Just like any other investment option, distressed debt investment is also not free of risks. Although, buyers of distressed debts often make large profits, they may have to endure huge financial losses in certain cases. If the company does not perform well, even after restructuring, then the investors have to bear huge losses. Oftentimes, during liquidation the proceeds may turn out to be pretty expensive thereby reducing the profit margin drastically. To minimize the risks, you need to thoroughly analyze the financial situation of a company before investing.
Distressed debt investment is exclusively for those who possess the requisite knowledge and acumen. Impeccable research and analytical abilities are a must for investors. It is definitely not for novices in the field of investment.
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