How to Change a Loan to Equity But Maintain Ownership

Debt vs. Equity

Q: I am the sole owner of an S-Corp that has received capital from a lender/investor in the form of a loan. Is there any way I can restructure the capital I’ve received to show up as equity instead of a liability to improve my balance sheet without having to sacrifice the ownership of my company? Basically, I want to keep the investors on a fixed annual return for their money, but classify their capital as a equity to meet certain net worth requirements for my industry.

A: You can change the debt to non-convertible preferred equity with an annual dividend and a return of capital terms that match the current debt repayment terms. S Corps are not my favorite form of entity, but this conversion should still work with an S Corp (I favor LLCs instead).

This type of preferred has the same basic features as debt, but it is considered equity instead so it meets your goal of moving the capitalization from a Liability to an Equity account on the Balance Sheet.

Also, because non-convertible preferred equity does not convert to common, once you’ve paid back the preferred, you will still end up as the sole owner of the company.

Of course this process will require good communication with the current lender, but because the overall terms are substantially similar and because it improves your ability to operate and grow the company, your lender should see the change as a lower-risk option to them.

Be sure to get a good securities attorney to draw up the preferred instrument and document the transaction. There also may be securities filings and disclosures that are required, so this is not a transaction to be attempted without competent advice.

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About Wade Myers

Wade has founded or co-founded, invested in, and been a director of over 25 companies and has completed 55 financing and M&A transactions. His previous work experience includes the Boston Consulting Group and Mobil Corporation. Wade also served as an Airborne Ranger in the US Army where he was a decorated veteran of the Gulf War. He is a Baker Scholar graduate of Harvard’s MBA program and is married with five children.

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