8.2 Exit from the Perspective of the Investor 317Conversion. Third, the claims can be converted into other claims without the
firm making any payments in cash. For example, a loan may be converted into an-
other loan (novation), and the investor may have a right to subscribe for a number
of shares under the terms of a convertible bond. A share exchange means that a
shareholder will become shareholder of another company. A formal merger means
that a shareholder will either become shareholder of the surviving entity or receive
other consideration for his shares. A demerger means that a shareholder can be-
come a shareholder in a new company.
Changing the quality of claims without conversion. Fourth, the nature of the in-
vestor’s claims can be changed through one or more transactions without convert-
ing them into new claims. This will often make other forms of exit easier.
New equity investment can make debt instruments issued by the firm look more
attractive by reducing credit risk, and an LBO of the firm tends to make its debt
instruments less attractive because of a higher credit risk after refinancing.
A share exchange or merger can mean that a large and illiquid block of shares
is converted into a smaller and more liquid block of shares. For example, a reverse
takeover can change illiquid shares of a small listed company into more liquid
shares of a far larger company, and the illiquid shares of a large privately-owned
company into more liquid shares of a listed company.
Admission of the company’s securities to trading on a regulated market can
generally turn illiquid securities more liquid.
Particular forms of exit. Fifth, there are even particular forms of exit depending
on the investment.
For example, a simple term loan will be repaid on a certain date. A bank might
sell and transfer the loan before the repayment date.
In contrast, a limited-liability company cannot freely repay capital invested in
the purchase of shares issued by the company. A shareholder can nevertheless exit
the company in many ways. Shares can be sold. A large shareholder can offer
shares to the public. Shares can be bought back by the company, or the shares can
be withdrawn.
Asset investors can exit the firm in various ways depending on the investment.
For example, an entrepreneur might personally own part of the core assets of the
firm (such as intellectual property rights or real estate). If the firm is successful,
the value of those assets might increase. The entrepreneur might then exit the firm
by selling not only his shares but also those assets; the firm is de facto forced to
buy the assets if they belong to its core assets.
Walking away. Sixth, the investor may prefer simply to walk away. As a rule,
all kinds of investors can walk away, but walking away is constrained by the inve-
tors’ own obligations and interests.
For example, bad debts have an accounting life cycle. A bank would set the
portion of the loan portfolio that it does not expect to collect to the bad debt provi-
sion expense account. When the bank identifies a potential loan loss, it increases
its loan loss provisions. Potential losses are not immediately written off from the
gross loan balance. When the bank’s legal rights to a bad debt are extinguished
(for example, when a bad debt is sold), the bad debt will be derecognised and
losses will be written off.