When a company runs out of cash but still has a viable business, bankruptcy does not have to mean the end. Under Chapter 11 of the U.S. Bankruptcy Code, a company can keep operating while it works out a plan with its creditors. But operating costs money, and a company in bankruptcy usually cannot borrow on normal terms.
The solution is a debtor-in-possession loan, often called a DIP loan. The best way to understand it is to follow a company through the process. The one below is completely fictional, and every number is made up to show how the pieces fit.
Meet Brightwater Home Goods
Brightwater Home Goods is an invented chain of 150 stores that sells kitchenware and small appliances. It also has an online business that is growing. Over several years, it has built up debt to fund store openings and a new distribution center.
Here is its capital structure before trouble hits:
- A $200 million revolving credit facility backed by inventory and receivables, with $120 million drawn.
- A $300 million term loan secured by most other assets.
- $150 million of unsecured notes.
Sales have weakened, margins have narrowed, and several large suppliers are asking for payment up front rather than on credit. Cash is dropping by about $10 million a month. Management and its advisors conclude that the company cannot meet its next interest payments and needs a way to keep the lights on while it restructures.
The decision to file
Brightwater’s board brings in a restructuring advisor, a law firm, and an investment bank to review the options. They consider an out-of-court deal with lenders, a sale of the business and a Chapter 11 filing.
An out-of-court deal needs broad agreement among lenders, and the lenders are not aligned. A quick sale does not look possible at a fair price. So the board chooses Chapter 11, aiming to restructure the debt and close the least profitable stores.
On the filing date, three things happen right away:
- The company files a petition in bankruptcy court.
- An automatic stay takes effect, which stops most creditors from collecting debts or seizing assets.
- Brightwater becomes a debtor in possession, meaning management continues to run the business under court supervision.
This is the point where cash becomes the central problem. Suppliers want payment, employees need wages, and landlords want rent. The company needs money now.
Why Brightwater Needs a DIP Loan
A company in Chapter 11 faces a funding gap that regular lenders will not fill. New lenders worry that their loan will sit behind the existing debt, which is already larger than the business is worth. Suppliers want assurances of payment. Customers worry about warranties and gift cards.
A DIP loan solves this by offering the new lender strong protections that the Bankruptcy Code allows with court approval. In general terms:
- The DIP lender can receive a superpriority claim, meaning it is paid ahead of many other claims in the case.
- The loan can be secured by liens on assets, and in some cases the court can approve liens that rank ahead of existing ones if the existing lenders are protected. This is called a priming lien.
- The loan is made under a budget that limits how the money may be used.
Those protections are why a DIP lender is willing to lend to a company in Chapter 11. The risk is lower than a typical loan to a distressed borrower, and the pricing often reflects the special situation, with fees and interest that are commonly higher than on healthy-company loans.
Sizing and Structuring Brightwater’s DIP
Brightwater’s team builds a thirteen-week cash flow forecast, which is standard in restructurings. It shows how much cash will be needed to pay suppliers on new terms, make payroll, fund inventory for the holiday season and cover professional fees.
The forecast shows a peak need of about $75 million over the first four months. The team asks for a DIP facility of $100 million to leave room for surprises, with only part drawn at first.
Key terms in the proposed DIP:
- New money. $100 million, with $50 million available after the court’s first hearing and the rest after a final hearing.
- Interest and fees. A rate above what the company paid before, plus an upfront fee and an unused commitment fee. The exact levels depend on market conditions.
- Milestones. Deadlines for filing a plan, getting a court order approving a sale process or emerging from bankruptcy. Missing a milestone can trigger default.
- Budget covenants. The company agrees to stay close to the forecast, and reports results weekly.
- Maturity. About a year, with the option to extend if milestones are met.
Who Provides the Loan
DIP loans often come from existing lenders. Existing lenders are already exposed and know the business, and a DIP loan lets them protect their position and have more say in how the case proceeds. Sometimes the DIP is offered as a roll-up, where some of the existing debt is converted into the new facility and gets the improved ranking. Other times, outside lenders such as credit funds bid to provide the DIP, and the company chooses the best offer.
In Brightwater’s case, two groups submit proposals. One group is the existing term lenders. The other is a credit fund unrelated to the case. The company’s investment bank runs a short competitive process and compares:
- Total amount and timing of funds.
- Pricing, fees and any roll-up of existing debt.
- Milestones and flexibility.
- How the terms affect the other creditors.
The company chooses the proposal from the existing lenders, which offers a slightly lower rate and more flexible milestones, and negotiates final terms. Notice how much banker work is involved: building the forecast, running a lender process, and presenting the choice to the board.
Court Approval and the Role of Other Creditors
The company asks the court for approval at a first-day hearing, with the details in a motion. The judge usually approves a limited, interim amount to keep the business running and sets a later hearing for the final order.
Other creditors can object. The unsecured noteholders might argue that the terms favor the existing lenders, that the fees are too high or that the roll-up improves one group at the expense of others. The official committee of unsecured creditors, which is appointed in many Chapter 11 cases, reviews the deal and may negotiate changes.
Courts weigh whether the terms are reasonable and whether the company has shown it cannot get better financing. Negotiations often lead to compromises, such as a smaller roll-up or a longer window for challenging existing liens. Our guide to the sell-side M&A process shows how a sale is run, which is the route some companies in court take instead of a plan.
From Filing to Emergence
The months in court
With the DIP in place, Brightwater can pay suppliers, meet payroll and restock inventory. Over the following months:
- The company closes the weakest stores and renegotiates leases, which lowers fixed costs.
- Management and advisors develop a business plan and begin talks with creditor groups.
- The investment bank evaluates two paths: a plan of reorganization, in which creditors receive new equity or debt, or a sale of some or all of the business.
- The DIP lender monitors the budget and reports, and the milestones keep the case moving.
Assume talks lead to a plan under which the term lenders convert much of their debt into ownership of the reorganized company, the unsecured noteholders receive a smaller recovery, and the revolving lenders are repaid. Real outcomes vary a lot from case to case, and these are only illustrations.
How the DIP loan ends
When the plan takes effect, the company emerges from Chapter 11. The DIP loan must be repaid or converted at that point. There are two common routes.
- Repaid in cash from a new loan, often called an exit facility, arranged by the company’s bankers before emergence.
- Converted into part of the new capital structure, such as a term loan that continues after the case.
In Brightwater’s case, the company obtains a new exit facility from a group of lenders, repays the DIP, and the term lenders receive new equity. The business leaves court with far less debt and a smaller store base. If you want to see how a capital structure like this is modeled, see our explanation of the LBO model for related debt concepts such as secured and unsecured tranches.
Why Students Should Care
Restructuring groups at investment banks and advisory firms advise companies, lenders and other creditor groups on situations like this. Interview questions about DIP financing are not common for first-round internship interviews, but you may hear a basic one: “What is a DIP loan?” A good short answer is: “It is new financing for a company in Chapter 11. It gets priority over many existing claims, which lets the company keep operating while it restructures.”
Beyond that, the case is a good way to practice reading a capital structure, thinking about who gets paid first and understanding why timing matters in a deal. These ideas also show up in M&A and leveraged finance.
Key Takeaways
- A DIP loan is new financing for a company in Chapter 11, designed to keep the business running while it restructures.
- Lenders accept the risk because the Bankruptcy Code allows priority claims and liens, with court approval.
- DIP terms include new money, pricing, a budget, milestones and a maturity, all negotiated with lenders and reviewed by other creditors.
- Existing lenders often provide the DIP, sometimes with a roll-up, but outside lenders may compete.
- The loan ends when the company emerges, either repaid by an exit facility or converted into the new capital structure.
Want Personalized Interview Coaching?
If you are serious about breaking into investment banking, the best thing you can do is work with someone who has been through the recruiting process and knows what top banks look for. At Wall Street Mastermind, we have coached over 2,500 students through recruiting at bulge bracket banks, elite boutiques, and middle market firms. Book a free strategy call to learn how we can help you prepare.
Related Articles
- Comparable Company Analysis (Comps): A Step-by-Step Guide
- M&A Deal Process Explained: How a Merger or Acquisition Works From Start to Finish
- LBO Model Explained: How to Build a Simple Leveraged Buyout
- Moelis and Company Investment Banking: What You Need to Know
Follow Wall Street Mastermind
Stay up to date with the latest investment banking recruiting tips, technical guides, and career advice:
- YouTube
- TikTok
- X (Twitter)
- Podcast: Apple Podcasts | Spotify | SoundCloud
