Trends in Middle Market Turnarounds


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David Johnson is a career change agent who has served as interim manager or financial advisor on over $5 Billion of distressed middle market transactions.

In his nearly 20 years as a change agent, David has served as an advisor, board member, interim manager, investor and operator at organizations ranging in size from pre-revenue startups to Fortune 500 organizations.

David has several publications to his credit and is a regular speaker on the topics of change management, performance improvement, turnaround and restructuring. He received his MBA from the University of Chicago and completed his undergraduate studies at Fairleigh Dickinson University.

Published in: Business, Economy & Finance
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Trends in Middle Market Turnarounds

  1. 1. Trends in Middle Market Turnarounds Speaker: David Johnson March 29, 2012 1
  2. 2. Session Overview • Speaker Biography • Assessing the Situation • Role of an Advisor • 13-week Cash Forecast • Assessing Viability • Emerging Trends • Illustrative Case • Key Takeaways • About ACM Partners 2
  3. 3. Speaker Biography: David Johnson • David Johnson is a founding partner of ACM Partners, a boutique financial advisory firm focusing on turnaround and restructuring. His advisory experience spans North America and ranges from pre-revenue start-ups to advisory roles with Fortune 500 companies. • An active member of the turnaround community, David currently serves as Director of the Chicago/Midwest chapter of the Turnaround Management Association. He has numerous publications to his credit and has completed all qualifying exams for the CIRA and CTP. • David earned his MBA from the University of Chicago. His undergraduate studies were completed at Fairleigh Dickinson University. 3
  4. 4. Assessing the Situation “Some people seem to think there's no trouble just because it hasn't happened yet. If you jump out the window at the 42nd floor and you're still doing fine as you pass the 27th floor, that doesn't mean you don't have a serious problem.” – Charles Munger, Vice Chairman Berkshire Hathaway 4
  5. 5. Role of an Advisor • During the course of an engagement, a turnaround advisor will often be called upon to perform a number of critical tasks. While every situation is different, a lender can expect the following: – Increased Communication: A turnaround advisor will initiate weekly update calls with the lender overseeing the situation (whether the portfolio manager, a workout lender, or both). – Detailed Forecasts and Action Plans: Generally developing a 13-week cash forecast is the first order of business for an advisor. Such a forecast will be followed by weekly variance reporting, as well as regular updates on business trends and new developments. – Focus on Maximizing Cash Flow: All avenues for increasing cash flow are investigated. Generally collections are increased and inventory levels are reduced. Often costs can be reduced in the areas of equipment, labor, rent, etc. – Develop and Execute Turnaround Plan: Working with all stakeholders, the turnaround advisor will develop and manage a realistic turnaround plan. 5
  6. 6. 13-week Cash Forecast • The granularity of a 13-week cash forecast (“TWCF”) permits management and advisors to adjust the timing of payments to better manage cash flow. – What receipts can be pulled forward? – What disbursements can be delayed? • The TWCF places the focus on the situation as it is, not as it should be. – When do customers actually pay? – When are vendors actually paid? • By incorporating a working capital forecast for those companies funded with an asset based revolving line of credit, a TWCF provides a fairly comprehensive view into a company’s total borrowings relative to borrowing base, and as such provides visibility to lenders regarding the extent of any current or future over-advance situation. 6
  7. 7. Assessing Viability Turnaround Candidate • TWCF shows a manageable peak cash need (i.e. lender or other stakeholder is willing and able to “fund the burn”) • There is a clear short-term path to reach operating cash flow break-even • Given a successful turnaround, company has a future with current or prospective stakeholders (i.e. owners’ equity not wiped out in plausible upside scenario, lender fatigue has not set in) Liquidation Candidate • TWCF shows a peak cash need in excess of what lender or other stakeholders are willing or able to commit • No clear path to reach operating cash flow break-even • Owners’ equity wiped out in any plausible scenario, lender fatigue has set in, no interest from outside parties in going- concern sale 7
  8. 8. Liquidation • From a lender’s standpoint, a liquidation analysis answers, first and foremost, the question “am I impaired”? A lender overseeing an under- performing company financed by an ABL revolver should always seek assurance on their level of coverage in the case of a liquidation. • Turnaround advisors are skilled in the detailed assumptions that go into a robust liquidation analysis, in particular forecasting rates of recovery for different assets and managing administrative claims. • A liquidation is never a good outcome, but a successful liquidation is made possible by sufficient upfront effort in planning and detailed execution of the actual process. 8
  9. 9. Liquidation Cont. • Rates of Recovery: Experience dictates that few companies will realize 100% recoveries on the book value of assets. Determining realistic rates of recovery for a given company is crucial in a well-constructed liquidation analysis. – Inventory and M&E recovery rates are generally determined by referencing existing appraisal reports (when available) or arranging an expedited appraisal. The % of inventory sold into a particular channel (current customers, closeout buyers, etc) will strongly influence the outcome. For some inventory seasonality or the age of the product is a material factor (i.e. calendars, foods, etc). – A/R recoveries are often forecast based on more idiosyncratic factors, such as customer concentration and the strength of customer relationships. – Building and Real Estate recoveries are generally forecast based on the lesser of current market pricing or the most recent appraisal. 9
  10. 10. Liquidation Cont. • Management of Administrative Claims: Understanding liabilities associated with WARN Act (governing mass layoffs) and 503(b)(9) (governing recently delivered materials) claims, and doing everything possible to minimize those claims, can significantly impact a lender’s ultimate recovery. – Orchestrating layoffs in tandem with the cessation of certain functions (for instance, as WIP is converted to finished goods) can have the benefit of limiting the size of any WARN Act liability. – Careful planning and coordination prior to the start of a liquidation can serve to limit, or possibly eliminate, 503(b)(9) claims. 10
  11. 11. Emerging Trends 11 Deep Talent Pool Rapid Tempo Increased Asset Recoveries Active Distressed Investors Broad Refinancing Options
  12. 12. Emerging Trends Cont. Deep Talent Pool • As the turnaround industry has developed, lenders have found that they are able to better tailor their advisor recommendations to a given situation, minimizing costs and improving outcomes. • In taking advantage of these options, lenders should consider the following when determining which turnaround advisors to use: – What is the likely scope of the project? Is anything more than an assessment needed? – Is industry expertise likely to add significant value? – Are there weak spots in the management team that may necessitate an interim manager? 12
  13. 13. Emerging Trends Cont. Rapid Tempo • The tempo of turnaround situations, especially from the time that an advisor is retained, has undeniably increased in recent years. • Lenders can and should expect an objective assessment of a company’s near-term outlook, an action plan for managing through any liquidity pressures and the outlines of a long-term plan to fix or sell the business within weeks. 13
  14. 14. Emerging Trends Cont. Increased Asset Recoveries • Asset recoveries have historically tended to be inversely correlated with levels of macro-economic distress (i.e. liquidations are broadly more successful in good economic times than bad). • As the broader U.S. economy has improved, asset recoveries have strengthened considerably from the lows seen in 2009. 14
  15. 15. Emerging Trends Cont. Active Distressed Buyers • The growing size of distressed asset investment funds has created a large number of potential acquirers of distressed companies. • With a pool of savvy financial buyers willing to pursue distressed acquisitions, whether out of court or in the context of a 363 sale, nearly any troubled company is a potential acquisition candidate for some buyer. • As a result of this dynamic, many turnaround situations now have a strong transaction orientation as turnaround advisors increasingly work to stabilize troubled companies in order for the company to be sold. 15
  16. 16. Emerging Trends Cont. Broad Refinancing Options • The growing risk tolerance of many banks, as well as the increased activity of traditional non-bank commercial lenders and more opportunistic special situations lenders, has created an environment in which many troubled credits can be refinanced if the incumbent lender is seeking an exit. 16
  17. 17. Many Avenues to a Positive Outcome 17 • An incumbent lender willing to continue supporting an under-performing company is generally seeking a rationalized cost and capital structure. Turnaround • Often lender fatigue has set in in a turnaround situation, and the best outcome for all parties is for the company to find a new lender. Refinance • Fatigue sometimes extends beyond the lender to management and ownership. This may call for a distressed sale process. Sale Process
  18. 18. Case Overview • In June 2010 a prominent distressed investment firm acquired an $85MM Chicago-area restaurant company out of chapter 11 bankruptcy. • The predecessor firm to ACM Partners was retained as turnaround advisor to support the executive team. • The company presented a number of challenges: – Cash Management – Lack of a Coherent Strategy – Nonexistent Projections & Reporting – Unstable Executive Team – Tax Liabilities 18
  19. 19. Financial Forecasting & Reporting • ACM Partners immediately began work with the senior management team to develop a rolling 13-week cash forecast and initiate weekly cash reporting. • The next item of business was a collaboration with the executive team and new ownership to create an actionable strategic / financial plan for the medium-term (in this case, the next three years). • In addition to the weekly cash reporting, the company’s new owner also required a highly detailed monthly operating report. With no internal resources capable of managing this reporting requirement, ACM Partners took charge of this role. 19
  20. 20. Process Improvements • With the major financial forecasts and projections built, and financial reporting running smoothly, ACM Partners began assisting the management team in building a firmer long-term foundation for success. • Working with the company COO, ACM Partners developed a decision tool that would permit management to quickly assess the attractiveness of individual expansion opportunities. • ACM Partners worked with management to develop a flexible and easily implemented system that allowed for variance reporting by restaurant, region or company-wide. For the first time, senior management had visibility into the performance of each restaurant against its budget. 20
  21. 21. Knowledge Transfer • ACM Partners worked closely with the company CFO to ensure a smooth transfer of knowledge. • Three separate staff members were trained on the financial reporting aspects owned by ACM Partners (cash management & reporting, 3-year projections and monthly operating reports). Additionally, time was allotted for ACM Partners to shadow each process post-transfer to ensure a smooth transition. • In the case of the cash management function, ACM Partners also compiled a training manual as a reference tool. 21
  22. 22. Case Progression 22 Result: Company Finance Function Stronger than Ever Oversaw Knowledge Transfer to Company Employees Identified and Addressed Process Improvement Opportunities Assumed Ownership of Cash Management and Financial Reporting Developed Forecasts
  23. 23. Outcome • In a 4-month period, ACM Partners was able to manage and build out key finance functions and reports for a distressed company operating under new ownership. • As a result of strong cash management and a robust and well-supported 3- year forecast, the company secured a $7MM line of credit in order to fund its growth strategy. • At the conclusion of ACM Partners’ involvement the company no longer had to contend with a lack of reporting, incoherent strategy or a weak finance function. As a result of ACM Partners’ work, the company was well-positioned to return to growth. 23
  24. 24. Key Takeaways 1. Emerging trends in the turnaround industry have increased the options lenders have for navigating troubled situations to a successful outcome. 2. The baseline tools of a turnaround advisor (13-week cash forecast and liquidation analysis) can provide a high level of clarity into troubled situations. In those cases in which management is strong or the level of under-performance is moderate, a lender may only need a turnaround advisor to perform these analyses. 3. Regardless of scope, a turnaround advisor should be expected to increase communication and provide clarity and direction for an under-performing company. As much as an under-performing company needs a turnaround plan, it also needs credibility with its lender and other key stakeholders. 24
  25. 25. About ACM Partners • ACM Partners is a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. • David Johnson can be contacted at: – Email: – Ph: 312-505-7238 • For more information visit: 25