Distressed debt

Debt whose market rating has fallen sharply because the borrower has defaulted or is highly likely to default on repayments. The strategy of distressed debt companies involves first becoming a major creditor of the target company by snapping up the company´s bonds at pennies on the dollar. This gives them the leverage they need to call most of the shots during either the reorganization, or the liquidation, of the company. In the event of a liquidation, distressed debt companies, by standing ahead of the equity holders in the line to be repaid, often recover all of their money, if not a healthy return on their investment. Usually, however, the more desirable outcome a reorganization that allows the company to emerge from bankruptcy protection. As part of these reorganizations, distressed debt companies often forgive the debt obligations of the company, in return for enough equity in the company to compensate them. (This strategy explains why distressed debt companies are considered to be private equity companies.)