Eli5: How do CEOs from failing companies bail out with golden parachutes? Where does the money come from?
In: Economics
Here’s what a bankrupt company looks like:
It has $100m of assets and $200m of debt. That debt requires them to pay $5m a month in interest. Over time the company has been slowing running short of cash and so now it no longer has cash to make the interest payments. This triggers a default on the debt, making it immediately payable in full. So the company files Chapter 11.
[Important to note: Generally a company in Chapter 11 is cash flow positive – or could be if restructured – without the interest expense. The purpose of Chapter 11 is to restructure the debt / operations of the company to try to make it profitable.]
Chapter 11 in this situation generally results in the creditors taking over the business. But it takes a while to settle on what the business is worth, and which creditors get what.
To keep the company running during the bankruptcy process, the company will generally get a debtor-in-possession (“DIP”) loan. This loan has super priority and will be paid off first when the company emerges from bankruptcy.
The DIP financing (and possibly positive cash flow from operations sans interest expense) is where the money comes from to pay for things like executive compensation, as well as the various expenses incurred in the bankruptcy process. And ultimately, the cost is borne by the creditors. They’re now the owners now and they have to pay off the DIP loan when they take over.
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