Restructuring and Distress Concept Card Template (Runway, Waterfall)

Restructuring and Distress Concept Card: [Your name, elective or company, and date]

An elective-level concept card for corporate restructuring: how to measure a liquidity runway, value a distressed company, find the fulcrum security, design a debt-for-equity exchange, and see why holdouts and priority rules shape every deal. It is for second-year MBA students in a restructuring, distressed investing, private equity or advanced corporate finance elective and for candidates preparing for restructuring advisory, distressed debt and special situations roles. It builds on mba/mba-capital-structure-card (distress costs and the limits of leverage) and mba/mba-lbo-model-card (debt tranches and covenants) and does not re-teach them. Worked example A solves the restructuring of Tessmore Furniture Group, a fictional over-levered company; Worked example B is a half-solved case at a higher valuation; Exercise C asks for the minimum participation in an exchange offer and the cost of a gift to old shareholders. Source basis: Altman (1968), Myers (1977), Bebchuk (1988), Gilson, John and Lang (1990), Asquith, Gertner and Scharfstein (1994), Andrade and Kaplan (1998) and Gilson, Hotchkiss and Ruback (2000), written up in original words with fictional numbers. The legal map is jurisdiction-neutral in its method and names EU, UK and US rules only as dated examples. Replace every [bracketed] value and every row marked Example. This is a learning aid, not legal, investment, credit or tax advice; check the current official text and a qualified professional.

Document control

Contents

• When to use it
• The idea in plain language
• Formulas and notation
• Assumptions and limits
• How the parties use the analysis
• Legal map: how three systems answer the same questions (dated)
• Worked example A (fully solved): Tessmore Furniture Group
• Worked example B (half solved): a higher valuation
• Exercise C (unsolved): participation and a gift
• Connections to other cards
• Common mistakes and misconceptions
• Self-test questions
• My notes and next steps
• Sources and further reading
• Answer key

When to use it

Use this card when:

• a company's forecast shows that cash will fall below its operating minimum, a covenant test will fail, or a large maturity cannot be refinanced on current terms;
• you must decide which creditor class holds the fulcrum security, the claim that is only partly covered by the company's value and will therefore receive most of the new equity;
• a case or interview asks you to compare an out-of-court exchange offer with a court-supervised plan;
• you invest in, lend to, advise or work for a company whose debt trades at a deep discount and need to explain what each class can expect to recover.

Do not use the card to decide whether directors must file for insolvency, or how to vote in a real plan. Those are legal questions with duties and deadlines that differ by jurisdiction.

The idea in plain language

A company is in financial distress when it cannot meet its obligations to creditors as they fall due, or is likely not to. That can happen to a good business with too much debt, or to a weak business with any debt. Andrade and Kaplan (1998) studied highly leveraged transactions that became distressed and found that most of the lost value came from the business shocks and high leverage, with the costs of financial distress itself in a moderate range (they estimate 10% to 20% of firm value in their sample). The first task is therefore to separate the two: what is the business worth with a sensible capital structure, and how much debt can it carry?

Liquidity comes first. A company with positive value can still fail if it runs out of cash before a deal is done. The runway is the number of weeks or months until cash falls below the minimum needed to operate, measured with a direct cash flow forecast (finance/13-week-cash-flow-forecast). Suppliers tighten credit terms when they sense trouble, advisers cost money, and a single large coupon can bring the deadline forward by months.

Value is shared by priority. When a company is restructured, its enterprise value is divided among claims in the order of their rank: secured creditors up to the value of their collateral, then other senior claims, then unsecured creditors, then shareholders. Under strict priority (the "absolute priority rule"), a junior class receives nothing until every senior class is paid in full. The class whose claim straddles the value, partly covered and partly not, is the fulcrum. The fulcrum class usually becomes the new owner, because it has the most to gain from getting the value right.

Valuation is contested. Gilson, Hotchkiss and Ruback (2000) compare cash flow forecasts in reorganisation plans with market values after emergence and find that valuation errors are wide and that senior creditors gain from low values while junior claimants gain from high ones. Each class has a reason to argue for the number that puts it in the money. Expect a range, not a point.

Out of court or in court. An out-of-court exchange offer swaps old debt for new claims with the consent of each holder. It is quicker and cheaper but suffers from the holdout problem: each holder prefers others to accept the haircut while it keeps its full claim. Gilson, John and Lang (1990) find that firms are more likely to restructure out of court when they have more intangible assets, owe more to banks and have fewer lender groups, and Asquith, Gertner and Scharfstein (1994) find that public bond exchanges rarely solve distress when bank lenders do not also make concessions. A court-supervised plan can bind dissenting holders when the required majorities vote in favour, and in some systems can bind a whole dissenting class (cross-class cram-down) if protections are met.

Debt overhang explains why distressed companies under-invest. Myers (1977) shows that when debt exceeds value, shareholders refuse to fund positive net present value projects, because most of the gain goes to creditors. A restructuring that cuts debt to a sustainable level restores the incentive to invest. Bebchuk (1988) proposes using options to divide value among classes without a contested valuation, which is why the gift of warrants to junior classes is a common deal tool.

Early warning helps. Altman (1968) combined five accounting ratios into a discriminant score (the Z-score) that separated firms that later went bankrupt from those that did not in his sample of manufacturing firms. It is a screening tool, not a forecast, but it shows the patterns that lead to distress: thin working capital, accumulated losses, low operating returns, low market value of equity relative to liabilities, and low asset turnover.

Formulas and notation

Liquidity runway, with cash $Cash_0$, minimum operating cash $C_{min}$, undrawn committed facilities $U$ and average monthly net cash outflow $B$:

Altman (1968) Z-score for public manufacturing firms (the version with ratios as decimals):

Distressed enterprise value and distributable value, with a multiple $m$ of normalised EBITDA and restructuring costs $K$:

Recovery of class $j$ under strict priority, with claims $D_i$ ranked from 1 (most senior):

Plan arithmetic: new debt $D^{new}$ set by a target leverage $L$, new equity value and the fulcrum class's share of equity:

Exchange offer with participation $q$ and exchange ratio $x$ (new face per old face):

Excel: with each class's claim in a column ranked from senior to junior, recovery is =MIN(Claim,MAX(0,Distributable-SUM(Claims_above)))/Claim; Z-score is =1.2*WC/TA+1.4*RE/TA+3.3*EBIT/TA+0.6*MVE/TL+1.0*Sales/TA; runway is =(Cash+Undrawn-Min_cash)/Monthly_burn. Use a data table to show recoveries across a range of multiples.

Assumptions and limits

• Strict priority in the base case. Real outcomes often deviate: junior classes receive "tips" or warrants to secure their votes or avoid litigation, and some systems allow a relative priority rule. Exercise C prices one deviation.
• Two lien levels only. The revolving credit facility and term loan are treated as one first-lien class, pari passu. Real capital structures have intercreditor agreements, super-senior revolvers, structural subordination between holding and operating companies, and guarantees that change recoveries.
• Trade creditors rank with the notes. In practice critical suppliers are often paid in full to protect the business, which takes value from other unsecured creditors.
• One valuation multiple. A full analysis cross-checks a trading multiple with a discounted cash flow value (mba/mba-dcf-valuation-card) and a liquidation value, because creditors usually have a right to receive at least what they would get in liquidation.
• No tax effects. Cancellation of debt can create taxable income or reduce tax losses, depending on the jurisdiction; tax advice is essential in a real case.
• No new money. Many restructurings need new money from existing creditors or a sponsor, which usually ranks first and receives extra equity. The example funds costs from value.
• Liquidity forecast uses LTM EBITDA as monthly cash flow. A direct receipts and payments forecast is more accurate in distress.

How the parties use the analysis

The usual sequence of a restructuring follows the cash. The diagram below is the path Worked example A takes.

Legal map: how three systems answer the same questions (dated)

Every restructuring system must answer the same questions: can the company keep operating while it negotiates; who votes and in which classes; what majority binds a class; can a dissenting class be bound; and what minimum must each creditor receive. The table compares three examples as checked on 2026-10-30. It is a learning summary, not legal advice, and it leaves out many conditions, exceptions and national choices.

Questions to ask counsel in any jurisdiction: which procedures are available to this company; who can propose a plan; how classes are formed; what majorities apply; what the relevant alternative is and who proves it; whether new money can be given priority; and how long each step takes. Do not infer answers from this table.

Worked example A (fully solved): Tessmore Furniture Group

Tessmore Furniture Group is a fictional manufacturer and retailer of home furniture. A leveraged recapitalisation and a fall in demand left it with last-twelve-month (LTM) EBITDA of 40, against 95 two years earlier. Management's plan gives normalised EBITDA of 60. All figures are Example inputs in USD m.

Capital structure: revolving credit facility (RCF) 50, fully drawn, first lien, 8.0%; term loan 300, first lien, pari passu with the RCF, 8.5%; senior unsecured notes 200, 8.0%, coupons paid twice a year; trade and other general unsecured claims 50; cash 20; minimum operating cash 8. Funded debt is 550, or 13.75x LTM EBITDA and 9.17x normalised.

Step 1: liquidity runway (USD m)

Monthly inputs: EBITDA 3.33 (40 / 12); capital expenditure 1.50; RCF and term loan interest 2.46 a month (=(50*8%+300*8.5%)/12); a notes coupon of 8.00 in month 3; adviser fees 1.00 a month; suppliers shorten terms in month 1, absorbing 2.00 of working capital.

Cash falls below the minimum of 8 in month 3, when the notes coupon is due. The real deadline is the coupon date, not month 6. The company must use the time before it to agree a standstill, use a grace period if the bond terms allow one, or raise new money.

Step 2: early warning with the Altman Z-score

Example balance sheet and income data: total assets 700; working capital 10; retained earnings -40; EBIT 15 (EBITDA 40 less depreciation 25); market value of equity 30; total liabilities 650; sales 900.

Excel: =1.2*10/700+1.4*(-40)/700+3.3*15/700+0.6*30/650+1.0*900/700 = 1.32. Altman (1968) reported that firms below about 1.81 fell in the distress zone of his sample. Almost all of Tessmore's score comes from asset turnover; the profitability and equity ratios are close to zero.

Step 3: valuation range and waterfall (USD m)

Restructuring costs 15. First-lien claims (RCF and term loan) 350; unsecured claims (notes and trade) 250, pari passu.

Base case: =MIN(350,MAX(0,375))/350 = 100%; unsecured =MIN(250,MAX(0,375-350))/250 = 10.0%. The fulcrum moves from the first lien to the unsecured class between 5.5x and 6.5x, so the fight over the multiple is a fight over who owns the company.

Step 4: a plan at the base valuation (USD m)

Target leverage 3.5x normalised EBITDA, so new first-lien term loan 210 (=3.5*60). New equity value =375-210 = 165. First-lien holders are owed 350: they take the 210 new loan and 140 of equity, which is 84.85% of the new equity (=140/165). Unsecured creditors take the remaining 15.15%, worth 25, a 10.0% recovery, exactly the strict-priority result. Old shareholders receive nothing. Funded debt falls from 550 to 210, and leverage from 9.17x to 3.50x normalised EBITDA.

Why the deal must cut debt so far: debt overhang. Suppose shareholders could invest 20 in a store refit that raises distributable value by 25. Before the restructuring, claims of 600 exceed value of 375 before and 400 after, so the equity is worth zero both ways: the shareholders would pay 20 and receive nothing, and they will refuse. After the plan, the new owners keep the gain, so the project gets funded (Myers 1977).

Step 5: the out-of-court alternative and the holdout problem

Instead of a plan, Tessmore offers noteholders 50 of new second-lien notes for each 100 of old notes. With 90% participation, 180 of notes are exchanged for 90 of second-lien notes and 20 of old notes remain.

Value per 100 of old notes, with probability $p$ that the company survives to repay at par:

Tender at $p = 0.6$: =0.6*50+0.4*27.78%*50 = 35.56; hold out: =0.6*100+0.4*0 = 60.00. Each holder does better by holding out whatever the others do, so participation falls short. Even at 90% participation, leverage of 7.67x probably does not solve the problem. That is why exchange offers use minimum participation conditions, exit consents that strip covenants from bonds left behind, and why companies turn to court-supervised plans that bind a class by majority.

Worked example B (half solved): a higher valuation

Same company and plan structure as Worked example A, but the company's adviser argues for 7.0x normalised EBITDA.

Questions to answer: which class gains and which loses when the valuation rises from 6.5x to 7.0x? Why might the first-lien lenders hire their own valuation adviser? Is there any value for old shareholders at 7.0x under strict priority? [ ]

Exercise C (unsolved): participation and a gift

C1. Tessmore's first-lien lenders will agree to extend their maturities only if funded debt falls to 8.0x normalised EBITDA or less. With the exchange terms of Step 5 (50 new per 100 old), what minimum participation must the exchange offer require?

C2. In the plan of Step 4, the unsecured class agrees to give old shareholders 3% of the new equity to avoid a valuation fight. What is the gift worth, and what is the unsecured recovery after the gift? Under strict priority, why might a dissenting unsecured creditor object?

C3. In no more than 120 words, explain to a board why Tessmore's real deadline is month 3 and list three actions to lengthen the runway before then, with the party whose consent each needs.

Connections to other cards

Common mistakes and misconceptions

1. Starting with value instead of cash. A company with positive value can still collapse before the deal is done.
2. Using EBITDA as cash flow in the runway. Interest, coupons, capex, working capital and adviser fees decide the deadline; a single coupon can move it by months.
3. Valuing on trough or peak EBITDA. Use normalised EBITDA after the operational plan, and show a range.
4. One valuation number. Each class argues for a different multiple; show recoveries across the range and find where the fulcrum moves.
5. Forgetting restructuring costs. Adviser and court costs come out of distributable value before any class is paid.
6. Treating all unsecured claims as one block. Trade creditors, notes, leases and intercompany claims may be treated differently, and structural subordination can put holding company notes behind operating company trade.
7. Assuming an exchange offer reaches 100%. Each holder prefers to hold out; plan for minimum participation and for what happens to holdouts.
8. Cutting debt too little. A restructuring that leaves leverage near the old level often leads to a second restructuring.
9. Ignoring tax. Cancellation of debt and the loss of tax attributes can be large.
10. Reading the legal map as advice. Procedures, majorities and protections differ by jurisdiction and change with case law; check the current official text and qualified counsel.

Self-test questions

1. Why is Tessmore's real deadline month 3 rather than month 6?
2. Write the runway formula and name its four inputs.
3. Which of Tessmore's Z-score ratios contributes most, and what does that say about the score?
4. Define the fulcrum security. Which class is the fulcrum at 5.5x and at 6.5x?
5. Compute the unsecured recovery at 7.5x and show the Excel formula.
6. In the Step 4 plan, why do first-lien holders receive 84.85% of the new equity?
7. Explain debt overhang with Tessmore's store refit numbers.
8. Why does holding out dominate tendering in Step 5 at every survival probability shown?
9. Name two tools that reduce the holdout problem in an exchange offer.
10. What majority makes a class accept a Chapter 11 plan under 1126(c)?
11. Under Directive (EU) 2019/1023, what are the limits on the initial and total duration of a stay?
12. What did the US Supreme Court decide in Harrington v. Purdue Pharma L.P. (2024)?

My notes and next steps

Sources and further reading

Primary works:

• Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The Journal of Finance, 23(4), 589-609.
• Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147-175.
• Bebchuk, L. A. (1988). A new approach to corporate reorganizations. Harvard Law Review, 101(4), 775-804. https://doi.org/10.2307/1341173
• Gilson, S. C., John, K. and Lang, L. H. P. (1990). Troubled debt restructurings: an empirical study of private reorganization of firms in default. Journal of Financial Economics, 27(2), 315-353.
• Asquith, P., Gertner, R. and Scharfstein, D. (1994). Anatomy of financial distress: an examination of junk-bond issuers. The Quarterly Journal of Economics, 109(3), 625-658.
• Andrade, G. and Kaplan, S. N. (1998). How costly is financial (not economic) distress? Evidence from highly leveraged transactions that became distressed. The Journal of Finance, 53(5), 1443-1493.
• Gilson, S. C., Hotchkiss, E. S. and Ruback, R. S. (2000). Valuation of bankrupt firms. The Review of Financial Studies, 13(1), 43-74.

Official legal sources (checked 2026-10-30):

• 11 U.S.C. 1126 and 1129, Legal Information Institute, https://www.law.cornell.edu/uscode/text/11/1126 and https://www.law.cornell.edu/uscode/text/11/1129.
• Supreme Court of the United States, Harrington v. Purdue Pharma L.P., No. 23-124, decided 27 June 2024, https://www.supremecourt.gov/opinions/23pdf/23-124_8nk0.pdf.
• Companies Act 2006, Part 26A, https://www.legislation.gov.uk/ukpga/2006/46/part/26A (blocked automated access when checked; verify directly).
• Directive (EU) 2019/1023 on preventive restructuring frameworks, Articles 6, 9, 10, 11 and 34, https://publications.europa.eu/resource/celex/32019L1023.

Textbooks (further reading, by name only): Gilson, Creating Value through Corporate Restructuring; Moyer, Distressed Debt Analysis; Altman, Hotchkiss and Wang, Corporate Financial Distress, Restructuring, and Bankruptcy.

Open resource: OpenStax, Principles of Finance (CC BY-NC-SA 4.0), https://openstax.org.

Answer key

Worked example B: new equity =405-210 = 195; first-lien share =140/195 = 71.79%; unsecured share 28.21%, worth 55; unsecured recovery =55/250 = 22.0%. The unsecured class gains (10% to 22%) and the first-lien lenders lose ownership (84.85% to 71.79%) at the same face value of claims, so first-lien lenders have every reason to commission their own valuation and argue for a lower multiple. Old shareholders still receive nothing under strict priority, because unsecured creditors are not paid in full until distributable value reaches 600.

Exercise C:

• C1: funded debt after the exchange is =550-100*q (each 1% participation removes 1 of debt: 2 of old notes become 1 of new). For 8.0x of 60 = 480: =(550-480)/100 = 70% minimum participation.
• C2: gift =3%*165 = 4.95; unsecured value falls from 25.00 to 20.05, a recovery of =20.05/250 = 8.02%. A dissenting unsecured creditor can argue that a junior class receives value while its class is not paid in full, which strict priority forbids unless the class accepts; whether such a gift can be imposed depends on the jurisdiction's cram-down rules (LAW-04).
• C3: the month 3 coupon of 8.00 takes cash from 14.75 to 5.12, below the 8.00 operating minimum, and missing a coupon is usually an event of default after any grace period. Actions: a standstill or forbearance from first-lien lenders and noteholders (each lender group); deferral or cut of capital expenditure (board, within credit agreement limits); new money ranking ahead of existing debt (existing lenders, often with court approval in a formal process); agreed payment terms with key suppliers (suppliers).

Self-test:

1. Cash falls below the minimum of 8 when the 8.00 notes coupon is paid in month 3 (closing cash 5.12).
2. =(Cash+Undrawn-Min_cash)/Monthly_burn: cash, undrawn committed facilities, minimum operating cash, monthly net outflow.
3. Asset turnover ($X_5$, 1.29 of 1.32). The score is held up by sales alone; profitability, retained earnings and equity value are near zero or negative.
4. The class whose claim is only partly covered by distributable value. First lien at 5.5x (90% recovery); unsecured at 6.5x (10% recovery).
5. =MIN(250,MAX(0,435-350))/250 = 34.0%.
6. They are owed 350, receive 210 in new debt, and need 140 more, which is =140/165 = 84.85% of the new equity.
7. Claims of 600 exceed value of 375 before and 400 after the refit; shareholders would invest 20 for a gain that goes entirely to creditors, so they refuse a positive net present value project.
8. Holdouts keep a claim of 100 that is repaid at par if the company survives, while tendering caps the claim at 50; in default, the tendering holder gets 27.8% of 50 and the holdout gets nothing, but the survival gain dominates in every row.
9. A minimum participation condition and exit consents (or a court-supervised plan that binds a class by majority).
10. At least two-thirds in amount and more than half in number of the allowed claims of the class that vote.
11. Initial stay no longer than four months (Article 6(6)); total duration including extensions no more than 12 months (Article 6(8)).
12. That the Bankruptcy Code does not authorise a Chapter 11 plan release and injunction that discharges claims against non-debtors without the consent of the affected claimants.

Revision history

Standard and licence note

Based on standard corporate restructuring and distressed valuation practice, the primary works listed above, and the public legal texts named in the legal map, checked on 2026-10-30. The legal map summarises statutes, a directive and a court decision in original words with section and article numbers; it does not quote them at length and omits many conditions. The text, the model, the numbers and the exercises are original; no textbook, adviser training material or published case is copied or paraphrased, and Tessmore Furniture Group and every number in this card are fictional. The template is independent and not affiliated with or endorsed by any court, regulator, adviser, business school or publisher. Insolvency law differs by jurisdiction and changes with legislation and case law: check the current official text and a qualified professional before you rely on any row. This is not legal, investment, credit or tax advice. Template licence: MIT.