April 2010

Making the Liquidation Call

Recommending a liquidation can be among the most painful decisions a turnaround professional is forced to make, but it can also be among the most impactful in terms of preserving value. With preparation and a detailed plan, a liquidation can be carried out in an orderly manner that will maximize financial recovery and minimize disruptions to all parties involved.

At War With Failure, Not Reality
Turnaround professionals are a strange breed. They make their living serving clients on the razor’s edge of viability, not infrequently negotiating forbearance agreements to ensure that the lights stay on and payroll checks do not bounce. Yet despite their constant proximity to corporate distress, they hate to see a company fail.

But some companies do fail. And when that failure is apparent, when no turnaround plan is as viable or attractive as the prospect of selling a company for its component parts, it is the sad duty of the turnaround professional to make the stomach-turning call and advise liquidation.

Considerations in Developing a Liquidation Analysis
Before a turnaround professional can recommend either liquidation or support of a turnaround plan, a liquidation analysis should be performed. This analysis should, at a minimum, communicate to stakeholders the anticipated returns across the capital structure resulting from the sale of a company’s assets. Recovery rates, administrative costs and an accurate picture of the security interest of all tranches of debt are the key drivers of this analysis.

In determining liquidation value, a turnaround professional will start with the book value of assets per the most recently available balance sheet. The benefit of this approach is that it establishes a recognizable and unbiased starting point that all parties can agree on. Through detailed review of a trial balance the professional will further segment balance sheet line items as needed and identify those assets with no economic value (for instance, goodwill).

The recovery rates assigned to various assets are extremely important drivers of a liquidation analysis, as those rates will determine the expected gross proceeds from the liquidation. Given their importance, a turnaround professional will refer to all available information sources in estimating these rates. Sources will include recent inventory appraisals, precedential transactions, formal or informal polling of colleagues and general business judgment.

While not crucial, a well-considered liquidation analysis will include a carefully detailed build up of the administrative costs associated with the liquidation. One would typically expect to see costs associated with turnaround professionals and legal counsel as operational, financial and legal matters are brought to a close. Liquidators and others are often needed to expedite collection of receivables, sell off slow-moving inventory and conduct auctions for machinery and equipment. A detailed weekly estimate of these and other costs helps communicate to lenders that all viable scenarios have received rigorous attention, and that while it is understood that the turnaround professional may hope to lead a company out of financial straits, that desire has not interfered with a reasoned, objective analysis of the current situation and the best interests of all parties.

In forecasting administrative costs, particular attention should be given to the following additional key points:

WARN Act Liabilities

  • Enacted to protect employees from mass layoffs, the WARN Act and its requirements can often drive a wind-down schedule as turnaround professionals seek to realize maximum productivity out of employees and seek to minimize this liability.

503(b)(9) Claims

  • With careful planning in the timing of a filing, this liability can be minimized.

Security Costs

  • While not a large-cost item for most middle-market liquidations, this expenditure can help preserve significant value, as the value of empty buildings and unguarded equipment can be significantly compromised by vandalism and theft.

Commissions/Broker’s Fees

  • After addressing the gross proceeds and then the administrative expenses associated with liquidation, attention must focus on liabilities. Thorough review and understanding of loan documents is necessary to determine security interests and properly account for any personal guarantees by owners. Not infrequently lenders have failed to perfect their liens and find themselves in a weaker security position than they had thought. Additionally, owners are often surprised at the nature of the personal guarantees to which they have agreed. It is vitally important that a turnaround professional determine the true liability picture of the company, and not simply take the understanding of lenders and/or owners of their interests and obligations at face value.

Properly constructed, a liquidation analysis is a complex assessment that gives stakeholders an understanding of the potential losses they face should the company liquidate. These analyses tend to be contentious, and for that reason the experienced turnaround professional will strive to include sufficient detail and support for all key drivers in order for the analysis to withstand the scrutiny it is certain to receive.

View From the Trenches
The following two cases, based on recent engagement experience, showcase many of the points raised above:

Case #1 (Construction Supply Company):

The receivables of this $250 million were in doubt due to the declining financial prospects of its customers and inventory was nearly unsalable in certain markets due to regional economic factors. Consequently the liquidation analysis for this firm showed very weak recovery for A/R and inventory as well as a longer period needed to complete a collection/sale than would have been necessary in a better economic climate. Based on the strength of the final liquidation analysis lenders chose to provisionally support efforts at an out-of-court solution.

Case #2 (Tier II Automotive Supplier):

Suffering from the hangover of a leveraged buyout gone wrong, this company was simply over-leveraged and facing weak demand from its customers. With the liquidation analysis showing first lien lenders only marginally impaired, the onus moved to the second lien lenders and equity. Both the second lien lenders and equity, confident that the company was facing a cyclical trough and that higher returns awaited them should they support a turnaround plan, chose to do so.
In both of the above cases, a detailed liquidation analysis able to withstand the scrutiny of multiple constituencies was a key factor for lenders in making their decision whether or not to continue supporting a company.

When careful and reasoned analysis indicates that the highest and best use of a company’s assets is the sale of those assets in an orderly liquidation, it is the duty of a turnaround professional to recommend that course of action. In some cases there is too much fatigue among or between management, ownership and lenders to conceive of a successful turnaround, especially one that requires additional capital; and in these cases lenders are likely to place a higher premium on the speed of various exit options as opposed to the recovery. With preparation and a detailed plan, a liquidation can be carried out in an orderly manner that will maximize financial recovery and minimize disruptions to stakeholders, not to mention employees.

David Johnson is a director with ACM, a boutique financial advisory firm serving alternative asset managers, entrepreneurs and underperforming companies. He can be reached at 312-505-7238 or by e-mail at david [at] acmprofessionalservices [dot] com.