In this CFO series post we focus on key issues and potential solutions when dealing with a financially distressed business.
Your Team Matters
An established business has a multitude of various constituencies (employees, stockholders, creditors, customers), each of which is likely relying in part on the business’ continued viability. If the company’s very existence is threatened by a financial crisis, these constituencies are likely ill-served by a DIY approach – despite the likely costs of real professional help qualified in dealing with a financially distressed business.
But there is a myriad of advisors and approaches, and how do I choose the best one(s) for my company? What things should I consider in picking the right distressed advisory team?
If the decision-makers in your company haven’t been through such an advisor selection process before, it may be tempting to simply go with your existing professional relationships. However, like in most areas of life, blind faith is generally inadvisable. Using the conceptual framework set forth below, a company’s management can significantly improve the outcome of its selection process by determining what questions to ask and rank the advisors according to their answers.
Potential Issues Your Team May Face
Following are some of the key issues that we have found most important to Boards and management teams over the past 30+ years when dealing with a financially distressed business:
The company may need to obtain additional liquidity ASAP
Your existing investment bankers may have raised gobs of capital for you in the past. But that may have occurred during the company’s high-flying days when investors were very excited about the story.
Solution: The company needs to assess – realistically – whether its existing bankers can tap sources of capital that would actually be available under the current circumstances. And if they can’t, who can?
A series of financial crises is overwhelming for the company
In addition to liquidity issues, management is likely to find itself beset by all sorts of unfamiliar problems. Covenant defaults, employee defections, customer and vendor concerns about viability and lawsuits are just some of the crises companies should expect to encounter.
Solution: Clearly, Boards and management teams need to engage legal and financial advisors that have been through this before. Giving advisors “on-the-job training” can be a preventable recipe for disaster.
The Board needs to adopt a recovery strategy and get constituencies to march towards it
A financially distressed company rarely finds itself in a position where there is an obvious, quick fix. If such a solution existed, it probably would have been implemented long ago. Instead, companies must juggle competing considerations of valuation, creditor demands, sources of new capital, need for an Old Equity recovery, releases for Board members and management, tax and a myriad of other issues.
Solution: There is a huge difference in skill sets required for company-side restructuring advisors vs. those that work on the creditor side. Companies need to find debtor-side advisors that have the capital markets savvy to assess business values in the context of the company’s capital structure and future cash needs. The advisors will need to craft one or more restructuring plans that attempt to accommodate the disparate needs of the parties. And if the company wants to obtain recoveries for junior constituencies (such as Old Equity), the advisor will have to create levers to use to “encourage” creditors to allow that to happen (otherwise the restructuring could simply devolve to liquidation on behalf of creditors).
And someone needs to implement the strategy
When dealing with a financially distressed business, what the company wants and what creditors and other constituencies want are very likely to be completely different things. The company will have to identify financial and legal advisors that can drive a restructuring process in order to achieve the company’s objectives.
Solution: The Board will need to choose a team that can affect various capital markets transactions, both in the securities and M&A arenas. And the advisors will need to be well-schooled in techniques needed to corral an unruly group of creditors. The more the company wants to diverge from the creditors’ goals (such as by seeking a meaningful recovery for Old Equity), the greater the needs for advisors with negotiating abilities that run the gamut from a “soft” touch to a “take no prisoners” approach.
Conflicts of interest and undisclosed agendas are a minefield
Companies may be accustomed to engaging professionals and having them more or less do management’s bidding. That is not necessarily the case in the restructuring world. First, companies may not have a clear idea at the beginning of the engagement of their realistic objectives – and their advisors may have a major role in the shaping of such objectives. Second, advisors (particularly from the larger law firms and investment banks) may come with significant biases and agendas. Most of their restructuring business may come from creditors that they do not want to upset. In extreme cases, we have seen companies engage the investment banking arm of financial institutions that are existing creditors. Results from such conflicts are frequently unfavorable to Old Equity and other junior constituencies.
Solution: The Board must vet the institutional and other conflicts and loyalties of each potential restructuring advisor. Further, because many creditor-side firms may care as much about precedent as direct conflicts (they don’t want the result thrown back in their face in the next deal when they are on the creditor side), the Board needs to get assurances that such firms will recommend and pursue aggressive creditor strategies if they make sense for the company.
Obtain additional human resources
Is the existing cadre of management (particularly in finance) adequate to deal with the likely onslaught of problems? The importance of this issue is magnified when the company may also be facing reductions in force.
Solution: Depending upon the answer, the company may need to augment its team with a firm that provides interim management personnel that will be resident onsite.