Corporate Workouts: Light for Distressed Companies

by Steve Rockey

Companies under distress have alternatives to get themselves back on track. It may seem bleak sometimes but, as with any business, companies under distress should proactively pursue options. Out-of-court workouts are one of the tools to pull a company back on their feet.

Workouts are good for the creditors as well as the debtors. Creditors have the option to work with the company under distress in an out-of-court workout, or they can wait until things get worse, and deal with a bankruptcy where on top of all the legal hassles they will probably recover less.

Many times, the distressed company has fallen into their situation for reasons beyond their reasonable control.  Recently, workouts have been commonplace for residential real estate developers in Southern California . People are not buying homes, so developers are stuck with inventory they cannot sell. The better-managed developers have dealt with the situation before the situation deals with them. Workouts have been one of the strategies needed to survive.

The starting point of the workout is to determine the strategy. Financial structuring, balance sheet, income statement, cash flow are drilled into. Additional information from operations, sales, marketing, industry and competitive metrics are then gathered. This data along with many discussions is used to develop the strategy.

Creditors are categorized by size of debt, seniority of debt, type of debt, and remaining term. In a bankruptcy, creditors with the most senior notes are paid off first, or get the higher percentages, subservient debt gets paid last. During a workout, creditors with senior notes will usually demand restructuring of debt, because they know what payments they would get in the event of a bankruptcy. Subservient creditors will many times be more agreeable to write-downs.

Once the list of creditors, and "pecking order" is determined, the creditors are approached to negotiate alternative agreements to lighten the load on the distressed company; this includes banks, vendors, building owners, note-holders, trading partners, labor unions, and governmental entities.

The types of financial instruments and legal agreements get complicated, but at a high level, there are several potential methods of workout:

1. Get the lender to write down the amount they are owed, reducing the amount of monthly cash payments.
2. Get the lender to push out the terms of the repay agreements so the monthly payments are reduced.
3. Negotiate lower interest rates particularly if interest rates have dropped since the obligations were executed.
4. Find third parties to issue new forms of financing to pay-off or partially pay-off existing creditors.

Many times, some form of organizational restructuring goes along with the workouts. Restructurings vary widely, but some frequent types are:

1. Sell or close un-profitable divisions.
2. Raise cash by selling divisions that have a significant asset value  --  real estate, or possibly high market cap division.

Some of the pitfalls that must be avoided during a workout are:

1. Not enough time before cash runs out and bankruptcy is forced.
2. Cannot get consensus among the variety of parties involved.
3. Before general business arrangements are agreed to, the lawyers are brought in, and then disputes, billable hours and time crush the deal.

If the likelihood of a bankruptcy is pointing its' nasty finger at you, or you can see your company heading in that direction, take charge! A well-planned, out-of-court workout, before the panic of bankruptcy, is usually the best alternative.

Keep your business running well. Ensure it is operating, selling, marketing, and financially structured effectively to broaden the path for success and minimize the chance of distress.

Steve Rockey, known to his friends as "Rockey", is a Principal and an Interim Executive with Cerius Interim Executive Solutions, the largest provider of Interim Executive management services. 

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