Strip financing is the repackaging of different types of obligations—debt,
preferred stock
Preferred stock (also called preferred shares, preference shares, or simply preferreds) is a component of share capital that may have any combination of features not possessed by common stock, including properties of both an equity and a debt ins ...
, common stock etc.—into one security. The idea is to ease conflicts of interest and agency costs between the holders of the initial components, bond and stockholders.
In deals that are strip financed, returns to investors are generally derived from their equity positions (seen through how investors from time to time take losses on the debt components of the strip). Therefore, in a situation where a company is acquired through a strip-financed deal, and that company begins to default on loans, investors are more willing to renegotiate lending terms, thus avoiding the
hold-up problem
In economics, the hold-up problem is central to the theory of incomplete contracts, and shows the difficulty in writing complete contracts. A hold-up problem arises when two factors are present:
#Parties to a future transaction must make noncon ...
often seen in prior to and during bankruptcy. Also, repackaging can raise a securities'
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liqui ...
. One popular form developed in Canada was the Income Trust, which combined income from a
high yield bond with a
stock dividend
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re- ...
. Beginning in 2003 this concept was expanded to the U.S. when "Income Deposit Securities" (also known as Enhanced Income Securities) were first offered on the American Stock Exchange (AMEX). These consist of a high yield bond and a class of common stock committed to pay a high dividend from free cash flows combined as a single unit.
See also
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Securitization
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...
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Contingent value rights
In corporate finance,
Contingent Value Rights (CVR) are rights granted by an acquirer to a company’s shareholders, facilitating the transaction where some uncertainty is inherent.
CVRs may be separately tradeable securities; they are occasiona ...
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Earnout Earnout or earn-out refers to a pricing structure in mergers and acquisitions where the sellers must "earn" part of the purchase price based on the performance of the business following the acquisition.
Description
Earnouts are often employed when ...
References
Corporate finance
Securities (finance)
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