There are notably fewer corporate bankruptcies in the present economic climate than at the height of the financial crisis, yet many companies still face significant financial hurdles. Some distressed companies have been able to avoid bankruptcy by working with their existing lenders to amend or extend their loans, but in many cases, they must seek an outside investor or private equity partner willing to invest new capital into the company.
Certain lenders, especially non-bank institutions, have the ability to support and provide companies with flexible options to avoid a formal filing. However, the optimal route to completing a successful turnaround can often be through a traditional bankruptcy process. Though there is often a stigma associated with filing for protection under Chapter 11, if communicated correctly, it offers an opportunity for companies to get the “fresh start” they need to emerge from the turnaround process better equipped to operate in today’s market.
Turnarounds can take many forms in bankruptcy, but it is becoming more common for companies to leverage Chapter 11 as a means to seek a strategic sale rather than complete a plan of reorganization. Executing a turnaround is time-intensive and, as a result, typically a high-cost endeavor. Given that many companies in distress do not have the liquidity needed to fund the reorganization process, a strategic sale is often the most viable option.
Obsolescence Risk, Liquidity Issues
The Chapter 11 filing of National Envelope — the largest privately held envelope manufacturer in the United States — is a recent example of the benefits of a strategic sale. Despite a lengthy and successful track record developed over more than 60 years, the advent of new technology — namely electronic communications — and industry overcapacity put National Envelope at risk of becoming obsolete.
Additionally, the company had major operational issues, such as excessive manufacturing costs due to existing supply contracts, and had run into liquidity issues that hindered its ability to get the business back on track. By filing under Chapter 11, National Envelope was able to secure bankruptcy protection with a senior-secured debtor-in-possession facility from Salus Capital Partners, unlocking liquidity and ultimately facilitating a sale. The timeliness and execution of Salus Capital’s financing was critical in avoiding a liquidation, and enabled a number of facilities to remain open, saving more than 1,500 jobs.
Five Best Practices
Looking at the National Envelope bankruptcy process in more depth, we can point to five best practices that all lenders should consider when deciding whether to engage with a company seeking a turnaround:
Successful turnarounds require complete transparency between the company’s management team, its lender and its advisers (e.g., turnaround professionals, legal advisors, etc).
Turnarounds are already distressed situations with a myriad of time-sensitive issues, which, in turn, leave little room for mistakes. Lenders must enter the relationship with complete confidence in the management team and their ability to navigate the turnaround plan and operate the business effectively going forward. To accomplish this, asset-based lenders have a responsibility to conduct comprehensive due diligence on the company, its management and its collateral.
Having a meaningful understanding of the company’s go-forward strategy and the pledged assets will imbue trust into the viability of the turnaround and will ensure that the lender is comfortable with the collateral’s current and potential liquidation value.
In the case of National Envelope, the company had implemented a series of initiatives that resulted in significant increases in productivity and efficiency, as well as cost reductions that improved its path to positive cash-flow generation and profitability. Management also identified additional steps to accelerate returns to sustainable profitability, including continued execution of lean manufacturing, footprint rationalization and product differentiation. However, time and liquidity constraints prevented National Envelope from implementing these steps. With a solid collateral base, including receivables, inventory, and machinery and equipment, National Envelope represented an excellent candidate for financing from a secured lender’s perspective. Salus took the time to meet with the executive team and perform the diligence required to fully understand the eligible assets and the financing needs of the company.
2. Achievable Endgame
Before providing financing, lenders must set a realistic outcome for the turnaround process and be confident in the growth strategy of the business. The lender must consider current microeconomic situations, such as ensuring the right management team is in place, as well as current macroeconomic situations by understanding the market landscape and the demands for the business. Overall, the lender must decide not only if the endgame is achievable, but if there is a real need for the company’s existence.
National Envelope had an ecosystem of strategic partners with a great deal of interest in continuing the operations of the company. This network of industry support was a strong indicator that a successful sale was a realistic goal. Moreover, the fundamentals of National Envelope’s turnaround plan, which focused on product innovation, product quality and customer relationships, were a good fit for the changing dynamics of its industry and lay solid groundwork for executing a successful sale process.
3. Tailored Financing
Though specific milestones regulate the Chapter 11 process, lenders should not settle for standard solutions, nor should the companies they lend to. Instead, lenders must evaluate the company holistically to customize the loan, designing the structure to support the objectives of the turnaround plan.
The financing solution for National Envelope was tailored to maximize liquidity. Salus performed the necessary diligence to get comfortable with the collateral and the structure of the loan. Additionally, Salus worked with National Envelope and the company’s financial advisor to develop a detailed timeline with key milestones that fit with their turnaround plan.
4. Support of Key Stakeholders
In addition to a highly involved collaboration between the lender and the distressed company, gaining the support of the company’s many constituents is extremely important in implementing a turnaround plan. These stakeholders are vital to the company’s business and can potentially play a significant role in the future success of the company.
For example, supportive suppliers may be able to assist by extending payment timelines or modifying terms to make payments more feasible for the company. In the National Envelope turnaround, the company’s largest supplier and customer demonstrated their support by:
- Entering into an agreement that provided for the supplier to buy back inventory sold to National Envelope,
- Not seeking to credit bid or offset amounts owed for the inventory against accounts receivables, and
- Placing the supplier’s amortization at a standstill during the bankruptcy process.
Inviting stakeholders that have an interest in the company to be part of the turnaround process can help secure their support during this critical period and assist a smooth exit from Chapter 11, regardless of which path it takes.
5. Active Communication
Distressed situations operate at an intensely fast pace, which heightens the importance of aligned, expedient communications. In the turnaround’s execution, lenders and other key constituents must remain in constant contact with the company. Ensuring all parties are on the same page and kept abreast of every aspect of the proceedings can help expedite the sale process, reduce overall costs and reach a favorable outcome.
Throughout the National Envelope financing process, Salus, the company, financial advisors and other intermediaries communicated daily. While this may seem tedious and time consuming, a regular dialogue improved the efficiency and execution of the facility, allowing for a successful sale process and preventing an imminent liquidation.
National Envelope’s turnaround story is notable for its efficiency, quality of execution and successful sale. While the Chapter 11 exit plan and financing solution were unique to National Envelope, the lessons that can be gleaned hold true for any turnaround situation. Successful turnarounds require trust, forward-thinking and close collaboration between all of the company’s key constituencies, including management, advisers, potential buyers, suppliers and, of course, lenders. Most importantly, the company must have a realistic turnaround plan. Once determined, it is up to the lender to approach the Chapter 11 financing with the right flexibility and ingenuity to set the company on the path from bankruptcy to turnaround.
Kyle C. Shonak is executive vice president, Special Opportunities and Risk Management at Salus Capital Partners.