In this CFO series post we focus on the helping key leaders and decisions makers at a financially distressed company set priorities and goals.
Conflicting Advice for the Financially Distressed Company
As a corporate officer at a financially distressed company, do you find yourself being advised to do inconsistent things by different (existing and prospective) professionals and Board members? One group says to sell assets to pay down distressed debt. Another says to avoid divestitures, and to buy as much time as possible. Another says to go into bankruptcy and let the court sort it all out. All those points of view obviously can’t be simultaneously right. Further, something that was appropriate in one situation is not likely to be appropriate under a whole different set of circumstances.
How do you sort this all out?
The first thing you’ll need to do is to establish your priorities and goals to see how the advice you are getting meshes with what you want to achieve:
Just buy time. Management and the Board are convinced that operations have simply hit a bump in the road, and the company will be strongly back on track in a few months, then perhaps there is no need for wholesale divestitures or other radical restructuring alternatives. Instead, skillful advisors can persuade or force creditors to extend their obligations. If your advisors are not serving up solutions consistent with the realities of the situation, perhaps you should be asking for second opinions.
Is there an economic constituency that the company wishes to favor? Corporate Boards have wide business judgment latitude in determining whether the distressed company should go out of its way to help stockholders or one or more creditor groups. If, for example, the Board wants to maximize Old Equity recoveries at the expense of creditors, then red flags should go up when an advisor tells you that “if Old Equity is out of the money (determined by valuation waterfall of asset values vs. claims), then it should receive no distribution.” Or, “we need to sell assets in order to repay creditors to keep them happy”.
Far too many advisory professionals have agendas that may work at cross-purposes with their clients. For distressed companies seeking meaningful Old Equity recoveries, those adverse agendas may include lots of repeat business with a large creditor-side clientele. You want your professionals to protect you from risky actions. But you don’t want their conflicts to get in the way of your own objectives. It may be wise to jettison counterproductive advice – or even the advisor itself.
Why shouldn’t you just sell assets to make debt payments? Asset sales to generate liquidity may be inevitable for certain overleveraged companies. However, using the cash to repay debt at par may be a really bad idea. If a company has $10 of senior liabilities and $9 of market value assets, the junior constituencies would be 10% under water. Now if the company sold $5 of assets to repay $5 of face amount of senior liabilities, it would then have $5 of remaining senior liabilities and $4 of assets. The juniors would now be 20% under water. In other words, the company would not be shrinking itself to greatness – at least for junior constituencies.
But even if asset sales were the only viable path (see the “salvageable” thought below), companies and their Boards need to understand that their negotiating leverage drops dramatically once illiquid operating assets are converted into cash through a sale. Advisors that fail to take advantage of any negotiating leverage they have before the sale process even begins by wresting up-front economic and other concessions from senior groups for the benefit of junior constituencies. Obtaining such concessions may be the difference between having a viable reorganization vs. simply liquidating the estate for the benefit of senior creditors.
Realistically, is the company salvageable? If the business is already in a “death spiral” that no realistic amount of money will fix, then the best alternative may very well be a near-term sale. In restructuring situations, time and expense matter. Advice that leads down different paths can be distracting at best and maybe fatal to the best valuation realizations.
A Director said to let the Bankruptcy Court figure it all out. In general, simply plopping into chapter 11 is ill-advised. Companies that go into chapter 11 trying to find a solution typically do a lot worse than companies that go into chapter 11 to implement a well-conceived solution. Moreover, Courts do not create bankruptcy solutions (the constituencies and their advisors do), right all wrongs related to perceived bad actions or effect some other form of divine justice. What Courts do is call “balls and strikes” with respect to motions advanced by the company, creditor groups and other interested parties. In other words, they enforce the legal framework Congress established around bankruptcy.
What about getting sued by the creditors? Management and Boards should be rightly concerned about avoiding litigation against them personally and in obtaining releases in connection with restructurings. But that does not mean the company needs to do the creditors’ bidding. If the professionals are saying that there is an easy path simply by linking arms with one or more creditor groups, we would suggest first examining the professionals’ agendas before proceeding much further on such path.
Some of my advisors are telling me to take a “Quick Dip” in bankruptcy through a “Prepack”. This is a close cousin of the foregoing point. Maybe this type of advice will work for the company, but beware of solutions that sound too good to be true. There rarely is anything “quick” about a successful financial restructuring – unless the company is handing the keys over to the creditors. But if the goal is to get the company back on its feet as soon as humanly possible, without trying to allocate value away from more senior constituencies to more junior ones, then this kind of advice can indeed be appropriate.
Are you confused and daunted by all of this in your efforts to “do the right thing”? Just remember . . .
Don’t lose sight of the ever-present conflict of interest issue
Restructuring your company out of a financially distressed situation can be a “zero-sum” game, played by constituencies and their advisors that each come with distinct sets of baggage. That baggage can be a desire to reap as great an economic recovery as possible for you or the constituency you represent. Or it can be a fear of litigation. Or it can be a desire by a professional to curry favor with a future client (such as a creditor group in the case), who may be at odds with such professional’s actual client in the instant case. Each situation can be unique, with different overlays of liquidity, differing creditor rights and objectives, and values. Further, the rules of restructuring are arcane, and reflect the omnipresent “what if” world of what would happen in bankruptcy (whether the reorganization actually takes place in-court or out-of-court). And, of course, the process is generally highly contentious.