One of the most frequently-asked – and fundamental – questions from a corporate officer or Board member is “how bad a fix am I really in?” Most executives haven’t been through acute corporate distress before, and simply have no objective yardstick by which to measure the severity of their problems.
While, to some extent, each company’s challenges may be unique, there are many common elements that financially-troubled companies experience. I have set forth a series of “symptoms” below, and if your company has more than a couple of them, you should consider seeking help.
1. We are facing a cash crunch
Ebbs and flows of corporate liquidity are normal, and most teams can manage their way around them. However, if you have a major liquidity problem, your lenders are reluctant to advance more, or your trade vendors are cutting you off – and there is no imminent source of incremental junior capital, you probably have a three-alarm financial crisis on your hands. In the Adreima matter, we represented a Private Equity firm that had guaranteed the bank debt. To learn how we solved the cash crunch, partly through getting junior creditors to advance monies side-by-side with the Sponsor – while significantly reducing the Sponsor’s guarantee – see the Adreima case study.
2. We are in covenant default with our lenders due to operating underperformance
In most cases, covenant, or “technical”, defaults are surmountable. After all, the reason most banks put in these triggers in the first place is to give themselves the opportunity to reevaluate the situation before it gets worse. Lenders may give companies waivers for their initial technical defaults, perhaps after receiving a noncompliance fee. But after a string of such technical defaults, lenders may tire, and request that the company take steps such as refinance the credit or sell the business. Gordian frequently runs into problems like these. Through creating “carrots and sticks”, we were able to achieve a great result for our Private Equity client in Cross Match Technologies. Liquidity was enhanced, and the Sponsor’s guarantee was not called.
3. We have just had an unexpected calamity
You may have been sued. Or lost a major contract. Or experienced a significant loss. Depending upon the magnitude of the problem, these types of issues can easily threaten the company’s existence. Montreal, Maine and Atlantic Railway experienced a devastating blow when one of its shale crude-carrying trains exploded, wiping out part of a Canadian town. We were able to save the company through a sale to a third party following negotiations with national and provincial Canadian government entities.
4. Our securities prices have gone down the drain
A low stock market capitalization may signal an inability to refinance debt (as well as a diminution of the company’s prospects), and it is unlikely that such an event will have escaped the lenders’ notice. Debt trading at a discount to par (having “distressed debt” means your borrowing costs have gone way up) can be another big red flag. How much of a discount to be concerned about depends upon the security. Even a 1% discount on senior secured debt may be problematic, while concerns may not be great until there is as much as a 20% discount on unsecured bonds with a long maturity. Stereotaxis’ financial problems were exacerbated by the common stock dilution and price erosion caused by the PIPE securities it had issued. Gordian Group was able to reverse this vicious cycle through a series of restructuring actions, including negotiating with the PIPE holders to exercise their warrants instead of using such warrants to “short against the box”.
5. Our best people are starting to leave
While personnel or Board-level defections are not perfectly correlated with financial distress, they certainly can be another “red flag”.
6. Our hoped-for blockbuster project is a major disappointment
Many companies facing headwinds may have recently made a big bet on a major undertaking in order to turn the overall company around. The bet could be for an acquisition, a large capital expenditure program or a host of other initiatives. If the actual performance does not live up to the lofty expectations, it may be time to embrace current realities. Alphatec Spine had undertaken a comprehensive reshuffling of its US distribution strategy. When the operational reorganization failed, revenues and profits plummeted, and the lenders were pushing for a sale that would have left equity holders massively impaired. Gordian Group was successful in implementing a restructuring that resulted in Alphatec currently having an equity market capitalization in excess of $200 million, with virtually no debt.
7. We have mortgaged some of our future with early recognition of results
In corporate America, there can be heavy pressure to achieve immediate quarterly results, even at the expense of future periods. Future revenues and profits can be recognized today through programs known as “channel stuffing”, “loading” and so forth. Just as these techniques boosted reported results on the way up, they can magnify problems on the way down. If your company is heavily engaged in these practices on a regular basis, it can be another big “red flag”.
What’s the solution?
Diagnosing the problem does not take a lot of magic.
But what about solving the problem – while both protecting the Board of Directors and benefiting shareholders even under dire circumstances?
Because we alone in our field eschew financial creditor representations, we alone can give unconflicted, creative and effective advice to companies and boards who want to reallocate value from creditors to shareholders when faced with these challenges. Learn more about how Gordian Group’s unique skill set and tool box can help to remedy your distress.