Maximizing Value In the Painful Wind-Down Process: An orderly wind-down can optimize value recovery in a distressed company’s assets while reducing costs and the likelihood of future claims

Equity sponsors and lenders sometimes find themselves in a position where their company is losing money and they believe they’ve exhausted all options in their attempts to regain profitability. They have “had enough” of funding the company’s continuing losses through the conversion of rapidly depleting collateral or equity. In these cases, the bank is unwilling to provide additional support, the company has been unable to attract alternative financing, and equity is unable or unwilling to continue to fund the company. What working capital the company has, if any, most often comes from stretching the trade to the breaking point. The company’s financial decline usually has been going on for some time. Typically, word of the company’s situation has spread in the industry to the point where vendors are clamoring for payment. In fact, many will only supply product on COD terms or demand a portion of old debt on top of COD, further exacerbating the cash crunch. Customers are nervous about continued supply and are seeking alternatives. Meanwhile, payment of outstanding accounts receivable slow while customers determine the incremental costs of being forced to switch suppliers. Employees, who most likely have been kept in the dark, assume the worst and are paralyzed with fear of losing their jobs; those who can are fleeing. The ability to meet payroll for those who remain is often in doubt. Against this backdrop, wind-down specialists arrive on the scene to create and implement an exit strategy that maximizes recovery for all creditors – while minimizing costs and future liabilities. The factors that lead to success, regardless of type or size of business are as follows: * Analyzing how to extract value from cash flow, operations, assets, and potential exit scenarios; * Optimizing recovery potential by developing the optimal exit plan and choosing the best mechanism (in court versus out of court) for implementing it; * Reducing the likelihood of future liabilities by using the Bankruptcy Code as a roadmap; and, if applicable * Identifying the right potential buyers Implementing these steps within a framework of good faith, fair dealing, transparency, and commercial reasonableness provides a game plan that will bring integrity to the process and maximum value to stakeholders. Analyzing the Options There are several alternatives available for winding down and/or selling the assets of a distressed company. The alternative chosen will depend on the particular circumstances of the situation. So, the objective of the analysis phase is to determine which alternative can provide maximum value. Given the cash burn, negative earnings, and arguable lack of enterprise value, the knee-jerk reaction might be to shut down the business immediately. However, the best option is not likely apparent at the outset. A straight liquidation with assets sold in pieces at auction is often the least likely vehicle to maximize value recovery. In many instances, the best way to maximize recovery is to keep the company operating. By doing so you have the opportunity to garner value beyond that of the assets individually while limiting claims that could marginalize the recovery. An abrupt discontinuation of operations may have a negative impact on the ability to maximize accounts receivable collection and to extract value from work-in-process inventory. Immediate cessation will also diminish the value of intellectual property and increase the likelihood of additional claims from employees and vendors, as well as customers. Other options, such as winding down over time as work-in-process is completed and accounts receivable are collected or selling the assets as a package to a strategic buyer, may provide a far higher return for stakeholders, but they require incremental cash and time. Unfortunately, both are in short supply in such situations. Determining how best to maximize recovery and minimize future claims requires an analysis of the factors involved, including cash required to operate, status of raw material supply, asset types and conditions, and level of cooperation between ownership and creditors. But, there’s no running room to do an analysis if there’s no cash to operate. So, simultaneously we seek to stabilize operations and minimize the cash burn to provide the breathing room needed to pursue higher-yield outcomes. While operations are stabilized, we create a liquidation analysis that shows which option, given current conditions, will maximize recovery in the shortest time with the least cost. This analysis considers all factors that influence recovery and expense, including an in-depth review of the collectability of accounts receivable on an invoice-by-invoice basis, taking into account potential offsets and counterclaims that may arise “when the music stops.” Inventory is analyzed to uncover any excess raw materials that could be sold to competitors and/or vendors. Work-in-process is matched against backlog to determine if it makes economic sense to complete. Discounted finished goods are offered to existing customers while simultaneously being offered to salvage markets. Fixed assets are identified and shown to used equipment dealers and the brokerage community to estimate recovery values. Their feedback provides valuable information in setting baseline recovery expectations. The result of the one-to-two-week analysis phase is an exit plan and accompanying budget and cash flow projection. The budget serves as the road map, setting the baseline recovery expectation and highlighting areas where improvement beyond the baseline may be achieved. Maximizing Value The most common options for maximizing value in a wind-down are to shut down immediately and liquidate the pieces; wind down and liquidate the pieces over time; or continue to operate at a reduced level while seeking a strategic buyer for the assets as a package. Armed with the analysis we have created, we should now be in a position to determine whether there’s an underlying business that can be salvaged in some form or another. Sometimes, there’s not. In those cases, disposing of assets piecemeal makes the most sense. But, we are experienced in locating a pulse if there’s one, keeping the patient from getting worse, and possibly beginning to nurse it back to health and placing it with a new owner who can appreciate the business’s potential, all while amid chaos. When the business bears no vital signs, the indicators arising from the analysis are usually unmistakable. They include no order backlog; minimal, if any, saleable inventory; no proprietary intellectual property; obsolete equipment; environmentally challenged real estate; and/or an absolute lack of cash to operate. In these cases, the pieces likely will have more value than the whole and the results will be near or below baseline projections. The process for recovering maximum value in these situations will likely involve non-strategic third parties such as contingency-fee-based accounts receivable collectors, used equipment dealers, inventory salvagers, auctioneers, and/or real estate brokers. When the business is still viable in some form and recovery values are similar for an over-time wind-down and a sale of assets as a package, what determines the best course? Additional cash risk is not usually a tiebreaker as both scenarios will require some operating cash. Even in the “shutdown and break it apart” scenario, there are still costs such as personnel to show the assets, maintenance, insurance, utilities, and security. Sometimes, the time horizon to recovery will dictate. Sometimes, ongoing exposure beyond cash will trump. Sometimes, the market for the products will suggest a clear alternative. The answer to the question of which path to pursue is often “both.” In other words, create a plan that will have you prepared for the worst – a wind-down over time – while allowing for the best – a package sale of assets to a strategic buyer. The “both” answer often allows time for the process to unfold just a little. Without starting the process and beginning to generate cash, there will be nothing to sell because the bank will foreclose. But, at the same time, as long as the budget is met and weekly variances are positive, running room to clean the pony up and find it a new home may be possible. Maintaining credibility with all constituencies by showing progress is critical. Even at “breakup value plus fifty cents,” a package sale is advantageous given that transaction costs are lower and the transaction can often close faster than selling off the pieces, thereby reducing wind-down expenses and execution risk. The fact that employees may retain jobs, pensions and benefits, and that customer and vendor relationships may survive results in minimized claims. However, it’s likely the company has already been shopped to some degree and, for a host of reasons, an acceptable offer has not materialized. At the outset of these engagements, it’s difficult to convince stakeholders to put additional money and time at risk without a well thought out, rational, and achievable strategy that will provide incremental recovery commensurate with the additional risk. With a well-thought-out liquidation plan and a strict budget, however, one can enable discussions with potential suitors to take place simultaneously while the company is being wound down. Being able to show the constituencies that the process of recovery is underway and that you are not holding out for a white knight to save the day is critical. It may seem highly contradictory (especially to management), but only by starting the process of winding down will you have the opportunity for a better outcome. Minimizing Claims Maximizing value typically involves proceeding with a wind-down while looking for a strategic buyer. The other side of the equation involves minimizing costs and future claims. The two key considerations in this part of the process are the mechanics (in court or out of court), and the integrity of the process. Many factors play into the decision on mechanics, including the level of trust and cooperation among the owners, the management, and the secured creditor(s); the unsecured creditor constituency’s size and variety; the presence of employee issues; the potential acquirer’s desire to obtain title to the assets free and clear of all liens and encumbrances; and the need for protection and comfort of the company’s officers and directors. Generally speaking, court-supervised processes are better suited for cases involving larger and more complex creditor constituencies, WARN Act or other employee liabilities, sale-related issues, and the likelihood that the officers and directors will be second-guessed by those who are not paid in full. However, while not always doable, an out-of-court wind-down has two important advantages: increased speed and lower cost. Roughly half of our recent wind-down engagements have been conducted outside of any court oversight or other formal legal framework, including many that involved selling the company’s assets as a whole. A successful wind-down and liquidation can be conducted out of court when the hostility and claims arising from the process can be managed without court supervision. Successful out-of-court wind-downs and liquidations are run as if they were in court and use key elements of the Bankruptcy Code as guidelines, giving the process credibility. At the heart of the process is integrity and fairness. Operating in good faith with open and frequent communication is vital to the success of an out-of-court wind-down. Operating as if the company had filed for bankruptcy protection provides a sound framework for action and communication, internally and externally, especially with creditors. To start with, the point at which the decision is made to liquidate the company for the benefit of its creditors should be viewed as a quasi-petition date. This is especially true when it’s thought that all creditors may not be fully paid. Perhaps the two most important guidelines are to pay no “pre-petition” debts while making sure that no creditor becomes worse off than they were “pre-petition,” and to incur no new debt without a high degree of certainty that it can be repaid. Adhering to these guidelines is easier said than done. Vendors do not like being told their old debts are frozen while being asked to provide continued goods and services on a go-forward basis. In our experience, though, creditors will cooperate if they believe they are being treated fairly and other “squeaky wheels” are not getting greased. Having the message come from seasoned professionals with a proven track record goes a long way toward building trust and confidence among creditors that the company is doing the right thing by all. Letting creditors know that the senior secured lender has agreed to fund the wind-down and that the budget includes payments to creditors on a go-forward basis is critical in gaining their support. In some cases, we have formed ad hoc creditor committees and have implemented a formal process for communication. Sharing the budget and weekly variances with interested parties is also important to transparency. Keep in mind that at any time you could find yourself faced with an involuntary bankruptcy filing. Conducting the wind-down process as if the company is in a chapter proceeding from the outset will go a long way to ensure that your actions are not second-guessed by the bankruptcy court and the U.S. Trustee’s office. Also, upon a successful exit, it often makes sense to file a Chapter 7 bankruptcy petition to have an interim trustee handle a company’s final stage, e.g., when there’s ongoing litigation. The last thing you want is for a Chapter 7 trustee to find loose threads to pull on, possibly unwinding your good work. Attracting Buyers The budget is done and, after reviewing options, the stakeholders have agreed to a dual track process: begin the wind-down while seeking a strategic buyer. Mechanics and process have helped keep everyone on the same page and generally cooperative as the wind-down proceeds. What about finding a buyer? To be successful, you must find a buyer with four necessary characteristics: an appreciation of the opportunity, the ability to integrate the opportunity into its own infrastructure, the financial and managerial resources to make it happen, and the ability to move quickly amid uncertainty. Before the process is over, there will have been discussions with many who have some combination of two or three out of the four attributes. While it’s not easy to find someone with all four, it only takes one (two to have a race), and the vast majority of the time at least one interested party will be found. While conducting over a dozen of these engagements in the last five years, only twice were we unsuccessful in finding strategic buyers to purchase a company’s assets as a package, thereby providing creditor recoveries in excess of what would have been obtained in a straight liquidation. Within days we can identify potential targets – knife makers, cheese makers, foam rubber producers, ambulance operators, paper makers, liberal arts colleges, fuel cell producers, candlestick makers – whatever the market. The target list is sent a “teaser” of no more than 8 to 10 pages, designed to promote interest in the company and to commence a dialogue. This is not the typical investment banking “book” that takes weeks to compile and costs tens of thousands of dollars. The teaser takes a few days to produce – usually simultaneously with identifying targets – and includes a brief history, product and intellectual property information, markets served, a financial summary, as well as detailed inventory, equipment lists, and pictures. The due diligence process proceeds as the wind-down proceeds, and sometimes it’s a race to the finish line. As with all sale processes, the goal is to juggle cash required, price offered, speed to close, and terms. The only difference is that time, in these cases, is like a ticking bomb. Sometimes the ticking can help. When a company is failing to the point where key stakeholders have determined that it should be shut down and liquidated, the path chosen for doing so will have a significant impact on the outcome. Many times the obvious choices are not the optimum ones. While ceasing operations immediately can certainly have a positive impact on short-term cash, it can have severe negative effects on the final recovery. No decisions should be made without first conducting a comprehensive, yet accelerated, analysis of all areas of recovery and their associated costs. This analysis and related budget and cash flow will set the baseline, identify areas of upside, and serve as the roadmap throughout the process. The most significant upside will come from identifying strategic players and convincing them that your client’s distressed situation is an opportunity they should not let slip away. Our experience has taught us that the integrity of the process is as important as the result. Conducting the exit as if it were taking place in a bankruptcy, even if it’s not, provides for a sound and defensible framework. Following the tenets of good faith, fair dealing, adequate notice, commercial reasonableness, and the absolute priority rule will enhance your ability to maximize recovery while minimizing costs and the likelihood of future claims. Bruce Erickson is a Managing Director at TRG, a provider of turnaround, performance improvement, financial advisory, and wind-down/liquidation services. (c) 2007 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com