Traditionally, only a few restructuring solutions have worked for stakeholders in a distressed situation, often involving wiping out equity stakes and discounts to creditors. Today’s M&A world is a seller’s market. An abundance of capital chases too few companies to purchase. Private equity funds have a record amount of capital to deploy, recently surpassing a trillion dollars. Managers of private equity funds are under pressure to put their funds to work. Operating companies (or strategics) have all-time high stock prices and a record amount of cash on their balance sheets, increasing the average acquisition EBITDA multiple more than seven times. They have done everything to reduce costs, and are now turning to additional revenue sources to add profit. With the economy continuing to grow slowly, the easiest way to boost market share is an acquisition.
The capital for acquisitions is available, but most buyers have traditionally avoided acquisitions with even a hint of distress, aside from specialized distressed fund buyers who only want to purchase at steep discounts, or purchase bank notes at a haircut. As a result, the successful sale of distressed companies today relies on a process that addresses buyers’ fears while controlling for company stakeholder risks during the process.
The main strategy is to present the company at the value the buyer will achieve from an acquisition. By conceptually removing the distressed company’s negative associations and strictly controlling time and other aspects of the process to reduce risks, we restrict the buyer from leveraging the distress to reduce the ultimate purchase price. Each process should uniquely fit the particular company, but the following are key aspects of successful distressed sales:
Strategy, Timelines and Forecasts
1. Dive into the company and develop a strategy and strict timeline. Decisive execution-gaining buy-in from all parties is the goal. Weigh the tradeoffs of taking additional time to improve the company and allowing buyers to obtain new financing, versus the risk and cost of running the company. Make an evaluation. In some transactions it is worthwhile to get deeply involved, such as meeting with vendors in China to reduce prices, whereas in other transactions it serves the company best to bring the company to market quickly.
With distressed companies it is imperative to create a compelling narrative explaining the strengths of the company and clearly demonstrating how the company will return to profitability. Develop an easy-to-understand explanation, describing what happened and why the problem(s) will not affect the company in the future.
2. Create cash-flows, budgets and revised financial statements. Include reasonable adjustments to EBITDA, detailed year-end forecasts, and future year EBITDA and balance sheets. For a successful sale, reliable numbers are critical. The past numbers need to be shown in a realistic manner with easy-to-defend adjustments that help the buyer understand the cost of distress. Since past financial results have usually been negative, more effort needs to be put into forecasted near term numbers so the buyer can focus on the potential and likely value in the company’s future positive cash-flow. A clear explanation of why and how the company will be profitable after the transaction must be laid out. The forecasted numbers need to be tied to factual evidence that provides the most credibility, such as emails from buyers expressing the willingness to increase purchases.
In distressed sales, time must be taken to explain the value of the assets and a forecast of working capital. Although buyers may ultimately set their value on the expected future cash-flow, they will also be focused on downsides, and often can justify making the purchase on the value of the assets they will receive.
Support and Due Diligence
3. If necessary, entice the senior creditor to advance additional sums of support. Offer returns commensurate with inherent risks. Often in distressed situations the company and its lenders are in a log jam. The lender sees lending more money as putting “good money after bad.” Additional capital is needed to provide time for the sale, and to preserve the company’s value before it experiences irreparable harm by loss of customers or key employees. Finding immediate outside capital in these situations is nearly impossible. Often the only parties with the knowledge and interest are the parties already in the transaction. The best candidate is often the senior lender threatening to liquidate the company. The senior lender has the most at stake and already has security on the assets. A win-win situation can be fostered by providing incentives to the senior lender, such as increased interest rates and pay-off fees, thus securing financing for the duration of the process and continued support.
4. Engage a reputable third-party transaction firm to conduct sell-side due diligence. Sell-side due diligence is being used more frequently in all types of transactions. It is especially helpful in distressed sales for various reasons — reducing time to close, identifying problems and risks prior to going to market, justifying adjustments related to the distress, and most importantly, providing skeptical buyers with an unbiased, in-depth analysis of the company’s historical and financial performance.
Target and Entice Buyers
5. Present the opportunity to a large group of high-potential buyers. In any sale, the hope is to find the buyer that sees the most value in the company and its assets as a going concern. Since the stakes are high in a distressed sale, it is optimal to send a teaser to a wide group of strategics and private equity funds. Show the company at its best, but also be upfront about the difficulty the company has experienced. Without this initial disclosure, time will be wasted weeding out buyers that will quickly drop when they learn that the company has experienced distress.
Once on the market, a swift process is an absolute necessity. All sales have a tendency to drift, and the seller is most vulnerable once electing to go exclusive with one buyer. Up to that point, buyers are competing with each other and it is in their interest to keep their valuation high and present themselves as serious potential buyers. Once they have a signed a letter of intent (LOI) and an exclusive, they gain leverage. In a distressed situation, the risk at this point is particularly high. The company has a limited time to complete the transaction before liquidation. Thus, the exclusivity option should be eliminated, or the time frame of the exclusive should be reduced. One way to do the latter is to front-load the work that often delays a transaction, e.g., completion of diligence or APA schedules.
6. Use innovative techniques to entice buyers. In a distressed sale you are not just selling numbers, you are selling the company’s story. To comfort and interest buyers, present a webcast to all interested buyers. This strategy allows the seller to create a scripted presentation with management and other key players, such as the bank and sell-side diligence firm, to make a winning case. This is efficient for the buyers and seller. By presenting an in-depth discussion of the company’s status, buyers are quickly weeded out and unnecessary management meetings are avoided. The webcast can be a reliable tool to identify the highest-potential buyers while weeding out the uninterested, enabling swift negotiation and completion of the deal.
7. Focus on performance going forward. The M&A tradition bases valuation on a multiple of trailing 12 months (TTM) EBITDA. This theory does not hold true in the sale of a distressed company. For a distressed company to be considered at its true value, buyers must be focused away from TTM and towards either run rate EBITDA or forecasted EBITDA, reflecting the improvements and the fresh balance sheet that will be realized upon the sale and recapitalization of the company.
8. Run the sale as a controlled auction with a drop-dead close date. In a distressed sale, time is of the essence. The company is too vulnerable to allow for a typical drifting close date or for long periods of exclusive negotiations with a single buyer. At the very least, if the highest-potential buyer requests an exclusive, the auction date can be traded for a firm, swift close.
A good example of a successful distressed sale was Ravinia Capital’s recent sale of an industrial staffing company. M&A Advisor awarded us with the distressed deal maker of the year in 2014 for this transaction. The company, a $350 million revenue industrial staffing firm, grew too fast to support its own weight. The entrepreneur-run company had over-borrowed line availability and fell behind with trade creditors including tax authorities. The company faced a severe liquidity trap due to the overhang of delinquent tax liabilities. Ravinia Capital developed a bold and comprehensive sale process that enabled potential buyers to see the true value of the company. Working hand-in-hand with a restructuring firm, Ravinia Capital sold the firm to a strategic buyer.
There are many ways to run a distressed sale process, but a skilled and knowledgeable investment banker can help a distressed company turn a tragic losing situation into a “best possible” outcome for all stakeholders involved.
Tom Goldblatt is founder and managing director of Ravinia Capital.