Worst case scenario

Excerpt reprinted with permission from The Credit Crunch: a Practical Guide, Grant Thornton LLP, 2008


What’s the issue?
You’ve taken a hard look at your business and stress-tested sales assumptions, but your fixed costs are such that even break-even cash flows are based on certain levels of revenue. Your balance sheet is highly leveraged relative to your competitors. Your future is uncertain and trade credit is contracting. You’ve produced short-term cash flow forecasts and your current outlook is negative, and you foresee a serious liquidity crisis looming in the near term. A payment is due on bank debt, liquidity is waning and a default is imminent.

What can you do?
Don’t panic. The credit crisis and economic slowdown are impacting businesses across almost every industry and the entire credit spectrum, so you’re not alone. Carefully consider strategic alternatives. What are the advantages and disadvantages of restructuring a business through a formal insolvency process? Does a sale of all or part of the business make sense? Is raising equity an option? What is the enterprise value of the business, and is that value greater than the face value of secured debt? How do you determine the value of all or part of the business? In a financial restructuring, the critical issue is indicative value.

Look at your business without its existing debt and determine its debt capacity based on your most current financial projections. There are two fundamental approaches to determining debt capacity: leverage multiples and coverage ratios. Both are highly dependent on market conditions. Lenders and debt investors also look at alternative exit strategies, including the liquidation value of collateral and tertiary sources of recovery such as personal guarantees. Understand your bargaining position and your views on value. Consider your fiduciary responsibility. If you are operating in the “Zone of Insolvency,” your responsibility is to creditors, not to shareholders.

What to avoid?
Do not, under any circumstance, wait until you’re almost out of cash. Build cash reserves and hire professionals who can help you assess your options. Don’t assume the problem will go away over time. In most cases, doing nothing will cause value to erode rapidly. If possible, defer conversations with banks and creditors until a full game plan is developed. Do not agree to provide additional collateral or a personal guarantee in exchange for covenant waivers, until you have fully assessed your options.