Middle Market Business Assessments and Restructuring in the New Normal

Re-Opening Business
Industries are slowly opening for business again after an unwanted hiatus to deal with the pandemic. Healthy companies are facing liquidity risks, business plans prepared Q4 2019 and Q1 2020 are obsolete. Companies that were having issues prior to Covid are in survival mode and may be losing the battle. To help preserve borrower’s liquidity, we have seen lenders step-up and provide a moratorium on principal and / or interest payments and landlords have deferred payments as well. Companies have drawn down on their revolvers, procured loans on unencumbered assets and received PPP money. Hopefully, companies have been focused on reducing their break-even by executing on plans to consolidate plants, eliminating capital
expenditures without an appropriate funding source and starting with the c-suite, implementing salary reductions, furloughs and a hiring freeze.

What is on the Horizon?
It is already June and Q2 is almost in the books. There is high probability that companies will bust covenants at the end of the quarter and default on their lending agreements. Too many companies are not preparing for these events. They may eventually ask for 3-6-month forbearance agreement, further moratoriums on their debt payments and out of formula loans.

The lenders will then be in the unreasonable position of being asked to make decisions without having the requisite data to make them. Further, even if the company provides some level of forecasting, is it reliable? First, middle market companies are generally not very good at providing realistic forecasts and second, many managements will prepare the numbers assuming everything good will materialize without any downside risk. The result is an obvious complete waste of time. Savvy managements will hire financial advisors to lead the process, but the other 98% will require a strong push.

Financial Advisors (“FA’s”) can remove the clouds and present a clear picture on the horizon. The sooner a clear road map can be prepared, then the sooner parties can make decisions on next steps. Issues surrounding “base case” short term cash flow and borrowing base availability, collateral values, enterprise value and EBITDA and long-term viability are just some of the hot topics to be addressed immediately. Once the base case is understood, then performance improvement enhancements can be identified to improve upon the base case scenario. Not all companies are created equal so storylines vary from the good, the bad and the ugly. Regardless of the final storyline, the important thing is to determine where the company fits so business decisions can be made. It does not make sense for a lender to allocate a high percentage of their time on a company that is either non-viable or no longer fits the bank’s lending profile.

On the flip side, time is not the friend of a wavering middle market enterprise, so best to understand that asap before realistic options begin to dry up. The warning signs of a company in trouble are not difficult to see. Examples include growing past due payables, shrinking availability on the line of credit, tighter credit terms from suppliers, a looming debt maturity on the horizon without a plan to refinance it, poor quality and growing
chargebacks from customers, old equipment without the means to replace it, etc. All these examples are often predominant at the company long before a loan covenant is breached. Believe me, these issues are not foreign to company management, but rather than fix the problems, they react to the issues by hoping the economy takes off, revenue follows and they
sell their way to better days. Unfortunately, this almost never happens.

Options to De-lever When Liquidity is Low, Trade Debt High and Credit Terms are Tightening?
The bankruptcy process does offer a variety of tools helpful to the debtor, including the automatic stay, rejection of agreements and many others. However, it is also expensive, time consuming and stressful for ownership and management. Further, many middle market bankruptcies result in asset sales and/or liquidations with ownership walking away with nothing and they may have to make good on personal guaranties. Most middle market companies need debt restructuring done economically and fast. (1) A viable alternative to a federal bankruptcy filing includes an out of court workout where unsecured debt is frozen as a note payable and set aside in an unsecured creditors pool. The term of the pan (typically 3-5 years) would require utilizing a percentage of free cash flow (NI – debt service-capital expenditures) to provide prorata distributions to unsecured creditors twice a year. Any unpaid balance at the end of the term would be forgiven. It would be critical for the business owners to seek help from a financial advisor to provide not only the skill set to develop the plan but also the necessary credibility to gain buy in from the creditors.

Disruption often brings opportunity. Those companies that embrace it will adjust their operations and expectations in the near term and ready themselves for bigger and better opportunities down the road. Conversely, those that are less than enthusiastic may find themselves on the
wrong side of momentum, declining enterprise value and fewer options to restructure. Those companies may find themselves running for cover in bankruptcy. It is true that the bankruptcy process offers a variety of tools helpful to the debtor (Automatic stay, rejection of unfavorable
agreements, etc.) However, the bankruptcy process may not yield the results shareholders prefer (Not to mention the process is expensive, time consuming and stressful). Most middle market bankruptcy filings do not result in confirmed plans, but rather with a combination of a 363(b) assets sale and liquidations. As a result, secured and more likely unsecured creditors may be significantly impaired, ownership typically walks away with nothing and may have to make good on their personal guarantees. For those companies with a viable core enterprise but saddled with too much debt, an alternative to the federal bankruptcy process includes an out of court workout where unsecured debt is frozen as a note payable and set aside in an unsecured creditors pool. (1) For example, the plan term (three – five year time horizon) would require utilizing a percentage of free cash flow to facilitate pro-rata distributions to unsecured creditors twice a year. Any unpaid balance at the end of the plan would be forgiven. For this to occur, the unsecured creditors would need to receive more than they would in a liquidation and after considering the time value of money. In this instance, the debtor would certainly require outside legal and financial help to craft and execute a plan and gain much needed credibility from

About the Author

Michael Boudreau CPA, CTP CFF is a Director with Morris-Anderson, a financial consulting firm focused on restructuring and workouts, court appointed receiverships, debt refinancing, performance improvement, CRO and interim management, transaction advisory and other fiduciary services. Mr. Boudreau has operated and sold numerous business enterprises as court appointed receiver. Examples include manufacturing operations, senior living facility and real estate developments. He has 25+ years’ experience in the automotive supply chain as Financial Advisor, CFO and Treasurer. Mr. Boudreau also has extensive experience in numerous Commercial & Industrial (C&I) as well as real estate matters. Examples include health care, construction and contractors, aerospace, restaurant
chains, plastics, agribusiness, consumer products, logistics and others.

(1) For further discussion on this topic, see the March issue of CFO Magazine authored by Dan Dooley CEO of MorrisAnderson and Sheryl Toby Dykema Gossett PLLC.