What it means
When a company files for Chapter 11 protection in the United States, or an equivalent process elsewhere, its existing lenders are frozen and suppliers usually demand cash up front. Without new funding the business would stop within days, so the court can approve a facility that ranks ahead of pre-filing debt, sometimes even ahead of existing secured lenders.
The company continues to run its own operations, which is what the phrase debtor in possession means. For the business the point is survival and optionality.
DIP funding pays wages, keeps suppliers shipping and finances the professional costs of the restructuring, giving management months rather than days to sell assets, renegotiate leases or agree a plan with creditors. Without it, a reorganisation usually collapses into a liquidation that recovers far less for everyone.
Lenders accept the situation because of the protections they receive: super-priority status, security over unencumbered assets, tight covenants, a court-approved budget and strict reporting, often weekly. Pricing reflects the risk and the leverage, with high margins over a reference rate plus commitment fees, undrawn fees and exit fees.
The all-in cost frequently reaches the high teens or beyond in annualised terms. A common feature is the roll-up, where a portion of the lender's existing pre-filing debt is converted into the new super-priority facility as a condition of lending.
This is contentious because it quietly promotes old debt ahead of other creditors, and courts scrutinise it. Existing senior lenders often provide the DIP facility themselves precisely to keep control of the process.
For anyone reading the accounts, DIP borrowing appears as a liability with heavy disclosure, and the covenants usually tie drawdowns to a rolling thirteen-week cash flow forecast. Missing that forecast, rather than missing a profit target, is what typically triggers a default in bankruptcy.
In practice
Real-world examples.
Example
A national restaurant chain files for protection with $12,000,000 of cash and a $40,000,000 weekly payroll and supplier run rate. A $75,000,000 DIP facility keeps 300 restaurants open while the company rejects 60 unprofitable leases.
Example
An airline in reorganisation secures DIP funding backed by its landing slots and spare engines, assets that were unencumbered before the filing. The security package is what makes lenders willing to advance funds to an insolvent borrower.
Example
A steel processor's existing senior lender provides the DIP facility and rolls $25,000,000 of its pre-filing loan into the new super-priority tranche. Unsecured creditors object in court, arguing that the roll-up moves them further down the queue for no new money.
Formula
Calculation
Total cost of a DIP facility = Interest on drawn amounts + commitment or arrangement fees + undrawn line fees + exit fees.
A retailer in Chapter 11 arranges a $50,000,000 DIP facility for six months. It draws $30,000,000, pays an all-in interest rate of 13% a year, a 2% arrangement fee on the full commitment and a 0.5% annual fee on the undrawn balance.
Interest = $30,000,000 x 13% x 0.5 years = $1,950,000.
Arrangement fee = $50,000,000 x 2% = $1,000,000.
Undrawn fee = $20,000,000 x 0.5% x 0.5 years = $50,000.
Total cost = $1,950,000 + $1,000,000 + $50,000 = $3,000,000.
Measured against the $30,000,000 actually used, that is $3,000,000 / $30,000,000 = 10% over six months, or roughly 20% annualised. The board's test is not whether 20% is cheap, because it plainly is not, but whether six months of trading preserves more than $3,000,000 of value compared with an immediate liquidation.Case study
Seen in the real world.
Calder Home Retail is an illustrative, fictional furniture chain with 140 stores that filed for bankruptcy protection after two poor trading years and a supplier credit squeeze. On the filing date it held $8,000,000 of cash against roughly $22,000,000 of monthly operating outflows, enough for about eleven days.
The court approved a $60,000,000 DIP facility from a group led by its existing term lender, priced at 12.5% with a 2.5% arrangement fee and a roll-up of $20,000,000 of pre-filing debt. The facility released funds in tranches against a thirteen-week cash flow forecast, with a covenant allowing no more than a 10% adverse variance in any four-week period. Calder drew $38,000,000 over seven months at a total financing cost of about $4,300,000.
In that time it closed 45 loss-making stores, renegotiated 60 leases and sold its distribution centre in a sale and leaseback, emerging with a smaller but cash-generative business. The illustrative point is that the DIP facility bought roughly seven months, and the restructuring created far more value than the financing cost, which is the only justification for money this expensive.
Watch out
Common mistakes.
- Assuming DIP financing is a rescue investment that signals confidence in the business, when it is a secured, priority loan designed to be repaid whatever happens.
- Comparing the interest rate with ordinary bank lending, and ignoring arrangement, undrawn and exit fees that often add several percentage points to the all-in cost.
- Underestimating the covenant burden, since these facilities are typically controlled by a weekly cash forecast that leaves almost no room for variance.
Questions
People also ask.
Who usually provides DIP financing?
Frequently the company's existing senior lenders, who lend to keep control of the process, though specialist distressed funds also compete for the role.
Why would a lender fund an insolvent company?
Because the court grants super-priority repayment status and strong security, so the new loan sits ahead of the debt that already went wrong.
What is a roll-up in a DIP facility?
It is an arrangement where part of the lender's pre-filing debt is converted into the new priority facility, improving that lender's position and often drawing objections from other creditors.
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