Effective leadership of a distressed company (Learn the signs of distress) will consider and rank their objectives. Because if a company doesn’t do it, its creditors – or even its professionals – will do it themselves. Five of the key considerations we regularly encounter include:
- Does the Board want to maximize shareholder recoveries at the expense of creditors?
- Do they want to buy time in order to give operational initiatives the opportunity to play out?
- Is this an opportunity to clean up antecedent obligations at a discount in order to achieve a fresh start?
- Does the Board just want a fast M&A transaction in order to leave the problems behind?
- Is the company seeking to avoid bankruptcy at virtually any cost?
No one answer is right for all situations, and many potential paths are mutually exclusive. But thinking through the goals in advance can inform where you look for advice and whose advice you ultimately rely on.
Be Wary of Existing Relationships
If you are like most people, you probably feel besieged and in need of a great deal of good advice. Your first instinct may be to turn to your traditional coterie of advisors and relationships. But before charging down that path, recognize that not all of them have the requisite distressed experience. In fact, most don’t. Moreover, you will find that insolvency is somewhat of a “zero-sum” game, and many people who you turn to may have significant agendas of their own.
To underscore these issues, described below are potential pitfalls associated with each of a company’s customary “go to” relationships.
- Board Members May Not Have the Experience Because most of your Board directors likely haven’t been through financial distress before, they may have to go through the same learning process as management. And in these litigious times, individual Board members may be justifiably concerned with the prospect of getting sued for past or future actions. And advice (particularly early on in the process) from Board members needs to be considered in that context.
- Bankruptcy Lawyers Lacking Debtor Experience and Focus It is rarely the case that a company’s pre-existing law firm has the requisite expertise in advising debtors (i.e., the company itself). Even if the law firm has an insolvency practice, it may very well concentrate on the creditor-side practice, where there are many more opportunities for client representation. Unsurprisingly, many creditor-side law firms are reluctant to advocate (or even to mention) what could be considered “creditor unfriendly” strategies. If your company is also in payment arrears to the law firm, the prospect of getting objective advice may diminish further.
- Auditor Concerns About Their Own Liabilities Accountants that have done auditing work for companies are rarely in a position to actively help in a restructuring context. Given their potential exposure to litigation arising over past audit reports, these accountants may be reluctant to do anything productive, including remain as auditors.
- Current Banks and Other Lenders Will Be After Their Own Interests Clearly, lenders are going to be seeking their money back or to improve their prospects of future recovery. Such creditors may press for solutions that advantage them while leaving more junior constituencies impaired. A quick transaction at a “fire sale” price may get the senior banks paid in full, with little remaining for others. Accordingly, any advice coming from the banks should be taken with a large grain of salt.
- Existing Investment Banks May Lack Expertise in Distressed Situations Many investment banks seek to avoid distressed clients and may have already distanced themselves from the company. Others may say they have the capability to assist, but given their actual experience and concentration of ongoing creditor clients, may not be the right fit for the company. Further, if the investment bank has issued any securities for the company in the recent past (or is a creditor itself through its commercial banking affiliate), its conflicts multiply.
I am not by any means suggesting that all (or any) of a company’s existing relationships actually have insurmountable conflicts in being an integral resource to you. But I am alerting management and Board members that there may be potential problems with these resources that should be considered.
“If you don’t know where you are going, any road will get you there.”
~ Lewis Carroll, Alice in Wonderland
Strengthen Your Team with Outside Relationships
If your existing relationships need to be augmented, there is a mini-industry of professionals that has arisen to deal with the challenges faced by financially distressed firms. And as I alluded to above regarding a company’s existing law firms with insolvency groups, each of these outside firms may or may not have tight ties with the creditor community. Among many such firms, their constant stream of creditor referrals may be a lot more important to them than the particular results of any “one-shot” debtor gig.
- Select Your Law Firms. Regardless of what law firm you select, you will likely need legal expertise in (i) both out-of-court and bankruptcy restructurings, (ii) M&A and securities transactions, (iii) tax, (iv) litigation and (v) corporate governance. But that only gets you started. If your goals include maximizing shareholder recoveries at the expense of creditors, you will need attorneys who are creative, aggressive and not afraid to face off against creditors (when appropriate). I note that such firms are in shorter supply than those that will suffice for purposes of a quick bankruptcy sale or handing the keys to the creditors.
- Seek Financial Advice. Companies frequently seek assistance from investment banks or from “financial advisory firms” (often an affiliate of an accounting firm). Investment banks, like Gordian Group, help management and the Board with financial analysis, developing forecasts and business plans, dealing with creditor groups, and implementing solutions through M&A and financing transactions, including obtaining much needed interim financing. Learn more about how Gordian Group has helped our clients. Financial advisory firms render analytical and creditor interface services, but by law generally cannot execute transactions, as they are not registered broker-dealers. As with choosing law firms, a financially-distressed company needs to be cognizant of these financial firms’ potential conflicts with creditors and related representations – particularly if the company’s goals are geared towards shareholder recoveries. Be wary of the investment bank that says “we have great relationships with your creditors”. Such a statement may be a prelude to the company being sold down the river to its creditors.
- Employ Turnaround Managers. Turnaround or “crisis” managers can parachute into a company either as a sole practitioner or as an entire team. They may assume the responsibilities of the CEO or the CFO, or become the new “Chief Restructuring Officer” (CRO). In a substantial majority of the cases, turnaround managers are put into a company at the behest of creditors that have lost faith in the existing management team.
- Retain Independent Board Members. Believe it or not, there are actually senior executives that are eager and willing to serve on Boards facing financial distress (in exchange for a compensation package and D&O insurance). For companies seeking to effect transactions where existing Board members might be considered to be “interested parties”, having independent directors is essential to guard against prospective litigation.
Bringing on outside advisors is certainly not a panacea for a company’s woes, nor is an outside advisor necessarily superior to one in place today. But seeking input from one or more prospective legal, financial or other firms can possibly provide a new perspective and – depending upon the company’s goals – may be in a position to best help the company achieve them.
What’s All that Going to Cost You?
It’s not the cost of the advisors that you should be concerned about; it’s the cost of not having them that can hurt the most. Any company contemplating the need to deal with financial distress has to brace itself for what will be a very steep bill. Getting good advice in this arena is not cheap. And with the various creditor groups arming themselves with top-notch legal and financial professionals (for which the company will undoubtedly have to foot the bill), the cost of not having the right professionals on the company’s side can be incalculable.
Conclusion – Prompt preparation is essential
The onset of financial distress opens a new page in a company’s life. The company needs to reassess its goals and objectives in light of the current realities and prospects. The right advisors can guide management and the Board through this thicket. Such advisors can let management and the Board know what is achievable, and what may not be realistic under the circumstances, which in turn can help frame the company’s decision-making process. But the company needs to be wary that its preferred agendas may not mesh with those of potentially-conflicted professionals that have their own objectives, such as currying favor with some of the company’s creditor constituencies. And know that, without proper vetting, new advisors may have even more conflict “baggage” than the company’s existing coterie of professionals.
Perhaps it should go without saying, but a distressed company really needs to go out of its way to assemble a qualified advisory team that it can really trust.