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Restructuring for Small and Mid-Sized Businseses
The document discusses the challenges facing small and mid-sized businesses in the wake of a significant global economic downturn, which is projected to be three times worse than the 2008-2009 financial crisis. It highlights the importance of restructuring as a means for companies to buy time and align creditor interests while addressing the disparities in sentiment among business leaders. Various restructuring methods, including Chapter 11 bankruptcy, assignments for the benefit of creditors, and out-of-court workouts are reviewed, emphasizing the need for understanding stakeholder perspectives and securing adequate funding.
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Restructuring for Small and Mid-Sized Businseses
- 1. Restructuring for Smalland Mid-Sized Businesses July 2020
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- 3. Overview Abraxas Group LLC3Abraxas Group LLC 3 Revenue Count Category $0.5 - $1.0MM 830,000 Small Business $1.0 - $5.0MM 820,000 Small Business $5.0 - $10MM 160,000 Small Business $10.0 - $100.0MM 190,000 Middle Market $100.0 - $500.0MM 25,000 Middle Market $500.0 - $1.0B 4,000 Middle Market Total 2,029,000 The total universe of small and mid-sized companies in the United States is massive. Of those companies, the smallest form an overwhelming majority. 89% Small Business Middle Market Source: NAICs Association. “Counts by Company Size” https://www.naics.com/business-lists/counts-by-company-size/
- 4. Negative Business Sentiment Theabove values represent the quarter over quarter decline for that area. Abraxas Group LLC 4Abraxas Group LLC 4 1) Are business leaders being too optimistic about their business outlook? 2) Does the disconnect between revenue and profit expectations signal future challenges? 3) Are businesses taking the steps necessary to survive a long downturn? Sentiment Key Questions The results of a recent survey by the Association of International Certified Public Accountants highlight a stunning erosion in sentiment vs. Q1. Source: AICPA. “AICPA Business and Industry Economic Outlook Survey Q2 2020” https://www.aicpa.org/content/dam/aicpa/interestareas/businessindustryandgovernment/newsandpublications/downloa dabledocuments/2q-2020-eos-slides.pdf
- 5. Global Downturn Abraxas GroupLLC 5Abraxas Group LLC 5 With global GDP expected to decline by 10%, the current downturn is on track to be three times worse than the global financial crisis of 2008-9. According to a recent report by Moody’s Analytics: “Of the 8 million business establishments operating prior to the crisis in the U.S., it would not be surprising if close to a million do not make it.” Source: Moody’s Analytics. “Handicapping the Paths for the Pandemic Economy” https://www.moodysanalytics.com/-/media/article/2020/Handicapping-the-Paths-for-the-Pandemic-Economy.pdf
- 6. A Land ofGiants Abraxas Group LLC 6Abraxas Group LLC 6 The trend toward an increasing gap between large and small companies suggests that effective restructuring strategies will continue to diverge by firm size and complexity. Source: Harvard Business Review. “The Gap Between Large and Small Companies is Growing. Why?”, August 2019.
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- 8. What is Restructuring •A means to give time, and perhaps additional liquidity, to a company undergoing challenges • A method of reallocating creditor claims to more closely align with creditor risk tolerances • Generally associated with the acknowledgment of prior missteps Abraxas Group LLC 8Abraxas Group LLC 8 • An operational fix: In the industry, “restructuring” generally refers to transactions that alter the balance sheet (a refinancing or debt for equity swap, etc.), whereas “turnaround” implies a change in business operations (increased gross margins, improved working capital ratios, etc.) Restructuring Is Restructuring Is Not “Corporate restructuring entails any fundamental change in a company's business or financial structure, designed to increase the company's value” Source: NYU. “Corporate Financial Restructuring, Professor Ian H. Giddy” http://people.stern.nyu.edu/igiddy/restructuring.htm
- 9. Cost of Capital AbraxasGroup LLC 9Abraxas Group LLC 9 The challenge in the current downturn is ensure that capital structures can withstand an uptick in cost of capital after nearly forty years of a general downward trend. Source: Harvard Business Review. “Strategy in the Age of Superabundant Capital”, March 2017.
- 10. Capital Structure PeckingOrder Abraxas Group LLC 10Abraxas Group LLC 10 The risk tolerance of parties to a restructuring can often be discerned by referring to their position in the capital structure. Equity Trade Debt Unsecured Debt Subordinated Debt Secured Debt Category Example Secured Debt Any lender with a secured position relative to collateral, but generally a bank or commercial lending company Subordinated Debt Friends and family for convertible VC financing Unsecured Debt Private credit or mezzanine debt facility Trade Debt Accounts payable with suppliers Equity Owner(s)
- 11. The Lender Perspective AbraxasGroup LLC 11Abraxas Group LLC 11 In order to successfully plan and execute a restructuring, it is necessary to understand the perspective of lenders in general and your lender in particular. Risk Tolerance • Lenders generally operate on a risk tolerance spectrum, with those lenders providing the lowest cost funding being the most conservative lenders, and lender risk tolerance steadily increasing as the cost of funding increases. • Seeking to persuade a risk-adverse lender to support a restructuring plan through reference to upside potential is a common, and extremely counter- productive, mistake.
- 12. The Supplier Perspective AbraxasGroup LLC 12Abraxas Group LLC 12 Suppliers can be an invaluable help, or a severe impediment, in implementing a restructuring plan. • Often, suppliers are torn between a desire to resume normal business operations with a troubled customer and the fear of increasing their exposure. • Successful restructurings are often predicated on securing some level of explicit or implicit support from suppliers, generally in the form of extended payment terms.
- 13. In some casesa restructuring can consummated that provides additional liquidity (cash and untapped borrowing availability) to a company. This is most often the case when there is unencumbered collateral or when switching to a more risk tolerant class of lender. Funding a Restructuring Plan Abraxas Group LLC 13Abraxas Group LLC 13 An equity infusion is a common means of funding a restructuring plan and is often a requirement of securing concessions with more conservative lenders. Financing Asset Divestitures Owners Operational Improvement The sale of excess assets if a proven means of generating funds to support a restructuring plan. When a restructuring is paired with an operational component (a turnaround), the cash generated from the turnaround can serve as funding for the restructuring plan. This does necessitate careful coordination, and a high level of confidence in the operational improvement.
- 14. Chapter 11 Bankruptcy “Thischapter of the Bankruptcy Code generally provides for reorganization, usually involving a corporation or partnership. A chapter 11 debtor usually proposes a plan of reorganization to keep its business alive and pay creditors over time. People in business or individuals can also seek relief in chapter 11.” Abraxas Group LLC 14Abraxas Group LLC 14 Pros • Automatic stay from creditors • Clearly defined rights and protections • Increased availability of financing Cons • Very expensive • Extremely transparent process • Can extend the time to resolution Definition Pros & Cons Chapter 11 bankruptcy is the means of restructuring in the United States which offers debtors maximum protection. Source: United States Courts. “Chapter 11 – Bankruptcy Basics” https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-11-bankruptcy-basics
- 15. Assignment for theBenefit of Creditors “ABCs provide a state-law alternative to the filing of a federal bankruptcy case. Aptly named, they involve the assignment of an insolvent company’s assets to a third-party assignee, who is selected by the company and charged with the duty of liquidating the company’s assets to satisfy creditors’ claims against the company.” Abraxas Group LLC 15Abraxas Group LLC 15 Pros • Cheaper than chapter 11 bankruptcy • Faster than chapter 11 bankruptcy • Offers buyers protection from legacy issues Cons • Most effective in supporting the sale or liquidation of a business • Based on state, not federal, law • Not feasible for companies with broad operations Definition Pros & Cons State law alternatives to bankruptcy that are generally faster and cheaper while providing some level of protection to the debtor. Source: “Making Assignments for the Benefit of Creditors as Easy as A-B-C” https://ir.lawnet.fordham.edu/cgi/viewcontent.cgi?article=2542&context=ulj
- 16. Out of CourtRestructuring “An out-of-court restructuring or "workout" is a nonjudicial process through which a financially troubled company and its significant creditors reach an agreement for adjusting the company's obligations. A successful workout generally requires the participation of the company's lenders, major suppliers, and depending on the circumstances, other organizations or entities such as unions or governmental agencies.” Abraxas Group LLC 16Abraxas Group LLC 16 Pros • Ability to craft a bespoke solution • Potential for a rapid close • Key parties are able to control the process Cons • No easy means of forcing a resolution • Potentially expensive • No legal protections from other creditors Definition Pros & Cons The approach that offers maximum flexibility, both for good and for ill, is the out-of- court restructuring. Source: “United States: Restructuring Debts in and Out of Court” https://www.mondaq.com/unitedstates/insolvencybankruptcy/105646/restructuring-debts-in-and-out-of- court#:~:text=An%20out%2Dof%2Dcourt%20restructuring,for%20adjusting%20the%20company's%20obligations.&text=Id entifying%20and%20agreeing%20on%20the,potential%20solutions%20may%20take%20time.
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- 18. KeyTakeaways Severe Downturn With a downturn3X the severity of the global financial crisis of 2008-9 and the prospect of mass small businesses failures, challenges abound for small and mid-sized businesses. Business Sentiment Despite the considerable decline in sentiment among business leaders, there is some reason to believe that many decision makers remain unjustifiably optimistic, which may cause them to delay necessary changes to their business operations. Restructuring Restructuring is a means of buying time for a company and creating alignment among creditors. A restructuring alone does not strengthen a company. Stakeholder Perspectives The reaction of various stakeholders to a prospective restructuring is often best understood through reference to that creditor’s position in the capital structure. Abraxas Group LLC 18Abraxas Group LLC 18 Funding a Plan There are multiple viable sources of funding for a restructuring plan. Many small and mid-sized businesses will face challenges in the current downturn. Understanding restructuring offers consultants a tool to help these businesses reset.
- 19. David Johnson Email: david@abraxasgp.com Ph:312-505-7238 Twitter: @TurnaroundDavid David Johnson, founder and managing partner of Abraxas Group, has a 20-year track record of driving organizational change. David has served as interim executive or financial advisor to dozens of middle market companies in transition. Throughout his career, David has demonstrated a commitment to thought leadership, with numerous speaking engagements and articles on the topics of business transformation, change management, performance improvement, restructuring, turnaround and value creation to his credit. David received his MBA from the University of Chicago and completed his undergraduate studies at Fairleigh Dickinson University. Abraxas Group LLC 19Abraxas Group LLC 19