All businesses exist somewhere on a point that lie between good health and decline. These diametrical positions represent positions that I will refer to as a custodial or distressed environment.
The custodial environment is profitable. Both sales and margins are good. The company is liquid and relationships with various stakeholders are cordial. Potential threats from numerous stakeholders are minimal.
Overtime a company’s position will vacillate between health and prosperity. If deterioration continues unabated it reaches a point of actual distress. The distressed environment is diametrically opposite to the custodial environment.
Both sales and margins will have declined and the company is losing money on operations.Liquidity is impaired and the company is having difficulty in meeting obligations as they come due. Company morale is poor and there has been significant turnover. Given the lack of resources accounting/MIS has been impaired and the data available is flawed.Relationships with all stake-holders have been impaired. Potential threats exist from a number of these stakeholders. Among these the secured lender is the most important.
In this environment any threat can trigger a further deterioration and time is of the essence.
The Owner Operator- a Perspective
In the custodial environment the demands upon management are extraordinary. In a distressed environment these demands are overwhelming. This impairs both the decision making process and strategic implementation. Management may very well be over optimistic concerning such indicators as sales, margins and company value. Relations with the secured ender are likely strained at best.
The Secured Lender- a Perspective
The secured lender is clearly the biggest threat to the company and also a potential ally in recovery. They will consider the current situation as a “problem” loan. This refers to a company experiencing difficulty. Existing financial information indicates that the company will not be able to repay loans from operations.
It is from operations that the secured lender will expect payment. If this is not possible then they will seek payment from their security through the liquidation of assets. They will not support the status quo. Under the current circumstances the secured lender may have issued a for-bearance agreement or even a demand. The former is a provisional agreement for the company to continue, the latter is a requirement to pay.
It is likely that both the Owner and Secured Lender share a common goal which is to maximize the value of the company.
This is either to attempt a turnaround or to liquidate the company.
A legal Framework
The terms turnaround, restructuring, and bankruptcy are often thought to be interchangeable, and they are not.
A turnaround is a reversal of fortune. It has depth and scope and involves all aspects of a company. Restructuring refers to debt mitigation though a change in terms or even actual reduction. It may be done informally or through Bankruptcy. Bankruptcy or a Proposal under Bankruptcy refers to a Statutory restructuring of debt under Canadian Law.
Value Recovery
The valuation of a company as a going concern is often based upon some multiple of earnings. A company with negative earnings but is rather an asset sale. It is worth the underlying value of its assets. Such valuation should include an adjustment for the fact that any purchaser will pay less for distressed assets.
The best recovery will come from a successful turnaround. Notably as many as 90% of attempted turnarounds fail, this is because they fail to meet prerequisites:
1/ Competent management. The turnaround should be led by a Chief Restructuring Officer who is a seasoned professional.
2/ A viable core product, this is a product that is profitable or nearly so.
3/ Sufficient capital to plan and execute the turnaround.
Summary
A company in the later stages of decline has a unique relationship with its secured lender.The lender represents a lifeline for survival and a potential threat in seeking recovery of its funds. Both the lender and company have a common desire to optimize value. There are two choices courses of action available.
One option is liquidation or dissolution and the other is to attempt a turnaround. Liquidation will only recover asset value on a “fire sale “basis. A successful turnaround will yield some multiple of earnings as a value.
Most attempts at a turnaround fail because they did not meet necessary parameters for success.
These are;
1/ Competent management
2/ A viable core product
3/ Sufficient capital to implement a turnaround.
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