Is Byju’s Really Defaulting on Its Debt? Not Really

India’s highest valued start-up, Byju’s, has disqualified one of its lenders, Redwood Capital Management, for ‘predatory’ practices.

The company, which missed its $ 40 million interest payments, said it would hold off on interest payments unless the matter is settled.

The company was expected to pay the interest by May 25, with an extension until June 5. However, instead of making interest payments, the company is now looking to ‘disqualify’ its lender Redwood, which Byju says indulged in predatory practices.

The company’s debt, traded in the US, has fallen to around 65 cents on the dollar, which is in the distressed debt category.

While several social media handles ridiculed Byju’s for defaulting and disqualifying a lender, the situation appears to be a little more complicated than that.

Why Has Byju’s Refused to Pay Debts?

The interest payment is part of a $1.2 billion term loan that Byju’s had raised in November 2021, when ed-tech companies were an investor favourite.

Reports suggest that initially, the debt was supposed to be $800 million, but the amount was increased to take advantage of the lower rate of interest and the lenders’ willingness to lend money on easy terms.

In 2022, Byju’s kept stalling the filing of its financial results. After the first announcement in July 2022, the actual filing of the results was done in October 2022.

The long wait period attracted questions, and reports suggested that auditors had flagged concerns about how revenues were booked. Rather than booking revenue as it accrues over the years the user uses the product, it reportedly booked the entire revenue for multiple years at one go. Several ed-tech companies have used this practice to pump up accounting revenues.

Apparently, one of the terms of the $1.2 billion dollar was that the company was required to file audited results by September. At the same time, the markets got tighter, interest rates increased, and capital was difficult to come by.

Lenders asked Byju’s for a prepayment of a part of the debt, and both Byju’s and its lenders began negotiations. Byju’s even offered to pay higher interest to its lenders, but its lenders wanted $ 200 million in early repayments and increased interest rates. Meanwhile, Byju’s raised debt from external lenders and its subsidiary Aakash.

Byju’s term loan lenders pulled out of negotiations and moved to court, alleging that the company was hiding $ 500 million rather than paying its lenders back.

In return, Byju’s has refused to pay interest on its $ 1.2 billion loan and has accused Redwood of picking up Byju’s debt which sold at distressed levels. In its suit, it has sought to disqualify Redwood.

What is a Distressed Debt?

Distressed debt is debt that has a higher risk of default, and as a result, the price of the debt instrument falls. The lower price of the debt instrument would imply a higher yield to compensate for the higher risk the investor takes.

Distressed debt buyers often buy the company’s debt by paying a few cents for the debt instrument’s actual value, believing that the market’s perception of risk is higher than the real risk. These investors can even try to buy up large quantities of debt so that they can pressure companies into agreeing to more favourable terms for lenders.

Ideally, even if the company defaults, the low price paid for the debt ensures that the distressed debt investor can recover its money through liquidation.

If there is no default, the lender can generate high returns if the company’s financial situation improves or agrees to better terms. Competitors might also buy distressed debt to put more pressure on a company, force a default, and snap up the assets.

In the case of Byju’s, Redwood is accused of pressuring Byju’s to make prepayments of debt along with increasing interest costs.

What is a Disqualification List?

In order to save themselves from these attacks, companies have a list of disqualified lenders. These entities are not allowed to buy the company’s debt. And even if they do manage to buy it, the company can decide to reduce the lenders’ access to confidential information or limit their rights as a creditor.

The terms in a loan document help prevent unwanted lenders on the company’s creditor list.

Byju’s has said that its disqualification clause doesn’t allow distressed debt investors like Redwood to invest in its debt.

While Byju’s financials and alleged accounting practices are certainly alarming, it appears that Byju’s decision to miss interest payments stems from its belief that distressed debt investors were purposely sabotaging its financial health.

While it has refused to accept the lenders’ terms for now, the decision could have an effect on Byju’s fundraising ability in the future.