Risks are High
Don’t let anyone tell you otherwise. The debt is considered distressed, because many people don’t believe it will ever be paid back in full, if at all. There’s a chance the business repaying the debt could stop paying entirely if the business collapses.
However, as the saying goes: “high risk, high reward”. And with the risk of complete loss of capital, comes significant potential upside if the bet pays off. But if you don’t have the knowledge, capital, or very long term view to take on distressed debt, perhaps a better approach now would be to learn how to spread bet as this is an accessible and high return way anyone can start investing.
Investing in Turnarounds
If you believe a business is going to turn itself around, get out of the bad situation it’s in, pay off its debt, and go on to thrive, then your return can be very significant. But even if the worse happens and the business ends up in bankruptcy, since debt is given priority over share equity if a bankruptcy does happen, this does help to limit your downside too. So this can mean that in a wide range of circumstances, your return on capital through debt can be better than if you invested in the actual shares of the business.
Lend-to-own Investment
An alternative approach is lend to own. What this means is that if a company is entirely unable to pay off its debt, by owning the debt, it can give investors the leverage to take over the company. Even then if the company goes into bankruptcy, you’ll still be first in line to get repaid. Whereas if the company survives, and even thrives, you may end up owning a profitable enterprise at a huge discount.
Plus of course, since you own the debt, by becoming the owner of the company, you don’t have to pay back that debt since the money is yours, so immediately, the financial health of the business improves hundred fold.
Of Course Things Aren’t Quite So Simple
But let’s not pretend this isn’t a hugely competitive market, with high risks, high capital requirements, and considerable complexity. The process of investing in distressed debt is difficult and expensive.
One reason for this is since debt is of course not publicly traded, it’s not a liquid asset, so buying such debt can be a very difficult and time consuming process. Now as a retail investor, to be fully involved in this market is more than likely out of your reach, but there may be funds you can invest in, and other places to place your capital, where you may see the benefits of distressed debt investing, without having to dive fully into the business itself.
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