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What is debtor-in-possession financing in bankruptcy?

On Behalf of | Aug 22, 2022 | Chapter 11 Bankruptcy

One of the options available in California for alleviating insurmountable debt is Chapter 11 bankruptcy. When a business is heavily in debt, it might be able to qualify for debtor-in-possession financing.

An explanation for debtor-in-possession financing

Debtor-in-possession financing (DIP) is a type of financing available for companies that file for Chapter 11 bankruptcy. DIP allows a company to reorganize its finances while remaining in business to continue operating. DIP gives a company an opportunity to raise capital.

DIP differs from standard financing as it allows a business to get relief in bankruptcy while it gets the funding it needs to continue normal business operations. With regular financing, this is not an option as its main focus involves investing, merchandise and manufacturing.

How a business gets DIP financing

A business typically gets DIP financing shortly after filing for Chapter 11 bankruptcy. The process takes time, however, and once a lender is willing to extend financing to a company, the bankruptcy court must approve it. Once a lender steps forward and provides DIP financing, they are given priority on the company’s assets in the event that liquidation ultimately occurs.

An authorized budget must be in place for DIP financing to occur. This budget takes into account the business’ expenses, net cash flow, receipts and outflow of funds. Other details that are considered when creating the budget include various fees, seasonal changes in receipts, payments to vendors and capital costs.

After there is an agreement on the authorized budget, the loan’s terms, size and structure are also agreed upon. Terms of the loan typically include higher interest due to the company being considered a higher-risk borrower. DIP financing usually involves revolving credit so the company can borrow when needed and gradually repay the money.