Whatever You Do, Don’t Liquidate!
When a company gets into financial trouble, it often falls behind in its payments to its creditors, including secured creditors who have liens on the company’s assets. Secured creditors are always concerned that the value of the collateral assets will deteriorate if the company continues to falter, so they may want to quickly move to liquidate their borrowers’ assets to recover their money. Company owners with little experience in dealing with financial distress, loan defaults, and personal guarantees may succumb to pressure from that lender’s loan workout officers and agree to a liquidation.
At Ravinia Capital, years of experience with distressed situations have taught us that liquidating a company’s assets is rarely the best solution for either the creditor or debtor.
We implement a variety of strategies designed to address the unique circumstances of each company. Those strategies include operational support to quickly improve current operations and sourcing the capital necessary to preserve the company’s going concern value.
The unprecedented economic prosperity of the past decade, combined with low interest rates and an abundance of capital has significantly reduced the number of loan defaults and business liquidations. As financial distress has declined, the number of people experienced with managing through these more challenging situations has also declined. Workout departments at banks are a fraction of their former size, turnaround consulting firms and bankruptcy law practices have shrunk or shifted their focus elsewhere, and many of these professionals have retired since the last economic downturn.
The economics of the past decade have also contributed to an increase in the level of corporate debt. As the current expansion cycle reaches its end, this debt burden will bring financial distress to more companies. Predictably, loan defaults will return to normal levels, creditors will lose their appetite for risk and will demand repayment of their loans. As the number of financially distressed companies grows, so will the pressure to liquidate assets.
Why Companies are Worth More as Going Concerns
Companies should resist liquidation and find an alternative solution, because their value as a going concern almost always exceeds their liquidation value. For example, customers of an ongoing business are far more motivated to pay their bills than customers of a company in liquidation. Also, customers who would otherwise pay full price to a going concern will demand steep discounts for those same goods from a liquidating seller who cannot provide future customer service or warranty support. Similarly, operable machinery and equipment in place is worth more than its disassembled equivalent being sold at auction. Finally, the value of intangible assets such as intellectual property, customer lists, and goodwill simply evaporates in a liquidation.
In Ravinia Capital’s experience, any company that has achieved revenue greater than $25 million has a reason to exist – and value – despite current losses. Those losses might stem from a single adverse event, such as a large judgment or the loss of a key customer, or they could be a result of a cyclical downturn in the company’s industry, failure to respond quickly enough to disruptive new products and technology, or poor management. Regardless of the current problem, the company’s going concern value is usually greater than its liquidation value. When it is losing money, struggling to pay its bills and in default on its loan, a company’s true value is often obscured. As a result, Ravinia Capital focuses on capturing and promoting that value to those who will appreciate it.
If a “turnaround” cannot be accomplished, Ravinia will work with the company’s owners to sell their business as a going concern. Ravinia has extensive experience running a broad and robust sales process that reveals to buyers and investors the company’s inherent potential value and encourages competitive bidding for the company. A company’s real market value can’t be established until the company is properly exposed to a broad range of potential financial and strategic suitors. Each selling company and each potential buyer has its own unique set of circumstances that drive value for every combination. For example, one buyer may be interested in a company as a platform investment for future growth; another buyer may see great value in gaining access to a new market and obtaining hard-to-acquire customers; a buyer may also find value in the ability to increase production capacity by using the seller’s equipment. A company will never know all available options until it runs a proper sales process. For example, we once sold a toy company losing money for a high price to a family office that was collecting toy companies like one would collect toys.
Why Lenders Should Avoid Liquidation
Like company owners, secured lenders also benefit from preserving a borrower’s going concern value rather than liquidating the business. Those benefits include reducing the risk that liquidation proceeds will be insufficient to repay the lender’s loan, avoiding the cost of funding a liquidation, earning higher interest and fees for continuing to lend during the default period, retaining a customer who will continue to borrow and use a lender’s ancillary services after the borrower’s financial crisis has passed, and earning a reputation as a lender who will work with a borrower during a tough time.
Business Owners Should Explore All Options
When a company experiences financial distress, its owners and trusted advisors should remain calm, take a deep breath, and carefully explore all available options rather than quickly adopting the most expedient course of action. A top priority for a company that has defaulted on a secured loan should be retaining competent, experienced professionals who can identify and explain those options. The right professionals will work as the company’s advocate to achieve what is best for the company and its owners rather than run up hourly fees for themselves or curry favor with a lender who may send the professionals future business. We recommend that a financially distressed company discuss with its trusted advisors how to get the help it needs. Ravinia Capital can help them thoroughly explore all possible options and help them select the path forward that provides the best outcome.
JANUARY 9, 2019