For any asset-based lender, watching a borrower slip into distress is an unsettling experience. As results decline and the possibility of loan losses increase, lenders can find themselves backed into a position in which the extreme solution — a forced liquidation — seems to be the only way to recuperate the outstanding loan balance. These scenarios are made even more challenging by the fact that most asset-based loans are underwritten according to orderly liquidation value, rather than one based on a forced liquidation process. As a veteran third-party advisor to asset-based lenders, our experience has shown that asset-based lenders frequently have more options than they realize in dealing with distressed scenarios, and the temptation to move too quickly to a forced liquidation can result in significant — and, moreover, avoidable — destruction of value.
Though they are all too seldom utilized, there are options that can restore order to a potential forced disposition process and enable lenders to maximize recovery values: 1) transitioning the distressed business’ operations to a strong partner that can continue to run the company and provide additional “runway” for a true orderly wind-down; and, 2) structuring the disposition as a consolidated asset sale to a single buyer that has the insight and experience to monetize a company’s tangible and intangible assets. By moving to implement one of these options when a borrower begins to show signs of distress — and while sufficient elements of the company’s operating structure remain in place — lenders can exit troubled loans in a more structured manner and secure significantly higher recovery values.
Transitional Operating Partnerships: Buying Time Without Increasing Risk
The rationale behind the common industry practice of underwriting loans based on the net orderly liquidation value (NOLV) of collateral assets seems straightforward enough: asset-based lenders assume that any potential collateral disposition will be conducted in an orderly manner, and within a timeframe that allows the lender to maximize recovery values. Since the NOLV approach incorporates and “nets” the added “carry costs” of the longer liquidation, this approach has become the standard for underwriting asset-based loans.
In practice, however, executing on these assumptions in the face of potential losses from a distressed borrower is not always straightforward or easy. A troubled business may deteriorate more quickly than the lender anticipated, with competitors encroaching on customer relationships, closing off end-market demand and driving down the value of collateralized inventories and other assets. Faced with these circumstances, many asset-based lenders choose the easier path of proceeding directly to a forced liquidation in order to minimize risk, even though the recovery values they realize will most likely fall below the NOLV used in the underwriting of the loan and may force them to take a write-off on the loan.
However, by taking an orderly approach and engaging an experienced partner to run the business during an agreed-upon wind-down period, asset-based lenders can secure additional time to conduct a liquidation on a more structured basis. Such an operating partner may be able to leverage the company’s facilities, distribution channels, sales team and relationships in order to fulfill existing orders and continue to convert inventory during an established transition period. This approach increases the possibility of finding a strategic buyer that may want to purchase all or parts of the business. Most importantly, this method can provide opportunities to monetize some of the borrower’s intangible assets before they simply “evaporate” in a forced, piece-by-piece liquidation.
The obvious advantage to running an orderly liquidation is the element of time — additional time to find the optimum buyer of an asset is an easy concept to grasp. Another advantage, however, is the opportunity to institute a transitional operating plan, which can provide the time and structure that allows a professional to maximize recoveries through some form of continued production. In the simplest terms, the orderly process can enable a qualified disposition professional to continue to operate the business, converting work-in-process inventory that would otherwise have had negligible value in a forced liquidation into finished product, thereby driving a substantial difference in the overall recoveries. Asset-based lenders seeking to pursue this option, however, must act quickly once a borrower begins to show signs of distress. Acting early to align with the proper liquidation professional will significantly increase the likelihood of success by leveraging the necessary elements of the company’s operating structure that are still viable.
One recent example of a strategic, orderly liquidation was a transaction we led with an asset-based lender and its client, a manufacturer of branded and private-label candies that was experiencing distressed cash-flow and was unable to obtain additional financing. By all accounts, the borrower’s assets appeared to be headed for sale through a forced liquidation. However, we recognized that an orderly approach would provide the borrower with the necessary time to continue production — thereby converting inventory that would otherwise be taken to the landfill — while simultaneously securing time to seek buyers for the intangible assets.
After evaluating the company’s brand portfolio, manufacturing profile and leveraged assets, we acquired the senior debt of the borrower and placed the company into Assignment for the Benefit of Creditors. A professional interim management consultant was selected to assume oversight of all financial and operational decisions, and we continued operations based on the understanding that the recoveries on a forced liquidation would be a fraction of the dollars received in an orderly process. Ultimately, the longer runway this strategy provided allowed the unsalable inventory to be converted and sold as finished goods with positive margin contribution. Equally important, the interim management team successfully drove a significant improvement in the company’s operations, reversing substantial operating losses and generating an 11% EBITDA margin over the course of approximately one year. After the turnaround, we sold the senior debt position in support of a going concern sale of the company’s assets to a private equity firm. In this example, keeping the company together ensured that the final sale reflected the value of both the tangible and intangible assets, representing approximately three times the forced liquidation values in previous appraisals.
Global Multi-Asset Sales: Consolidating Assets to Maximize Value
In most forced liquidations, efforts are made to quickly ascertain the highest bidder for individual assets. Unfortunately, this hastened process eliminates one of the key benefits of a true orderly liquidation. Our experience has shown that real estate, equipment, inventory, accounts receivable and other assets are decidedly more valuable when coupled with intangible or “soft” assets, including brands, intellectual property, order books, customer lists, patents, trademarks and websites. With this in mind, a seller can realize significant incremental value by structuring a disposition as a consolidated asset sale to a single buyer with deep industry expertise, since this approach preserves the buyer’s ability to combine hard assets with soft assets on a selective basis.
This approach also provides a buyer with the opportunity to maintain a relationship with a business’ existing customers, since selling accounts receivable and remaining unsold inventory to one strategic buyer can eliminate potential friction with customers who may be the subject of collection efforts and ongoing sales efforts at the same time.
Even in an orderly liquidation, finding the right strategic buyer is not always simple. The process should allow the necessary time to identify and negotiate with a counterparty that will ultimately purchase both the tangible and intangible assets, typically at a multiple of the forced liquidation value on the hard assets alone. Ideally, lenders should seek to work with a firm that has experience in multi-asset liquidations and also is willing to take equity risk that will allow for maximizing the runway to complete such a transaction.
The recent disposition of a distressed manufacturer and distributor of legwear products provides a useful example. The borrower’s secured lender was looking for a way to exit its loan, which was collateralized by real estate, inventory, machinery & equipment, accounts receivable and brands. The lender recognized that a forced liquidation was not the best strategy, and began to explore an orderly wind down of the company. Based on our experience in the consumer products industry, we were able to quickly evaluate all of the asset categories. Recognizing that many of the company’s soft assets (primarily exceptional good-will with both key retailers and suppliers) would disappear in a forced liquidation, we proposed a global, multi-asset purchase agreement with the company that allowed for the appropriate amount of time to identify a true strategic buyer.
We purchased virtually all of the company’s assets, including raw material, work-in-process, finished inventory, accounts receivable, intellectual property, fixed assets and real estate. This creative solution allowed the lender to recover a significant percentage of its investment without the company entering bankruptcy. We were subsequently able to identify a strategic buyer in an adjacent space to purchase the assets that were most desirable for the go forward business, including intangibles, at an attractive valuation. Concurrently, we retained and monetized the remaining excess assets (including excess machinery and obsolete inventory) and entered into a long-term lease for the real estate facilities with the strategic buyer. This allowed the strategic buyer maximum financial flexibility with virtually no interruption to service levels to the market.
By engaging partners that have the capabilities to operate under a transitional operating plan during an agreed-upon wind-down period, asset-based lenders can give themselves additional time to maximize the ultimate liquidation value of the assets. An orderly liquidation approach structured around a global multi-asset sale to a qualified buyer or an experienced professional disposition firm should position lenders to recognize significantly higher recovery values.
Bob Maroney, co-president of the Commercial & Industrial Division of Gordon Brothers Group, works with clients to design and implement comprehensive, global solutions across a broad spectrum of the consumer product and manufacturing segments.