Finding your way to financial stability doesn’t have to be complicated. Look at refinancing, restructuring or selling.
June 30, 2011
by Christopher Porter
Business owners are inherently optimistic. “Our markets will expand. That big order will come in. Our profits will rise,” they proclaim, even when the chips are down.
Many of the optimists were proved right following the global recession. Canadian companies with low debt loads and cash on hand quickly bounced back.
Those who didn’t recover as quickly may have been unrealistically optimistic about their prospects. Accountants have a term for it: hockey stick projections. Banking on these types of projections may account for some of the 470 bankruptcies and 133 proposals filed by businesses between the end of September 2009 and September 2010.
Liquidating a business is the last option most manufacturers would choose to resolve financial difficulties. Manufacturing assets are not selling at a premium and liquidation typically leaves little or nothing for shareholders.
There are three more palatable solutions, but it’s necessary to first identify the source of the difficulties. Two problem areas are the balance sheet and the income statement.
On the balance sheet you’ll find over-leveraging or too much debt for the size of business; cost overruns, generally related to an expansion or relocation; and high levels of bad debts that could be caused by the failure of one or more major customers.
Typical problems on the income statement will be declining revenue due to customer attrition or new competition; outdated technology, resulting in lower efficiency than competitors; litigation that’s costly and a distraction for management; declining profit margins; loss of favourable customer status, discounts or payment terms; an increase in raw material prices that cannot be passed on; or significant management change, resulting in loss of efficiency.
Can the problems be fixed while maintaining a viable business? If the answer is yes, there are three options:
• Refinance. Canada’s 22 Schedule 1 banks tend to lend based only on predictable cash flow and extensive security, they charge less than other lenders.
Asset-based lenders will finance a company experiencing financial problems provided it has unencumbered assets and meets reporting requirements. Although these lenders charge higher fees than the banks and have more stringent monitoring requirements, they may advance more funds and be more flexible with companies in transition.
Factoring companies, which lend against accounts receivable, are helpful in situations where smaller amounts are required or an asset-based lender is not practical. While interest charges and fees are higher, they quickly turn accounts receivable into cash and will advance greater amounts than other lenders.
Mezzanine lenders offer a combination of subordinated debt and equity. They typically charge higher interest and incorporate options to convert outstanding debt to equity.
There are also lenders who will provide senior stretch or over-advance loans blending asset-based and cash-flow loans. They tend to support manufacturers with a solid asset base but lack stable or predictable cash flow.
• Restructure. Correcting underlying problems may require selling portions of the business, reorganizing or reducing operations. If there is insufficient time or money to complete a restructuring and there are many contentious issues or numerous disgruntled creditors, it may be necessary to file a notice of intention to make a proposal (NOI) or make a filing under the Companies’ Creditors Arrangements Act (CCAA).
A proposal is akin to a simplified CCAA. Because the rules are more cut and dried, professional fees for a proposal are less than those for a CCAA. Typically, a proposal extends an offer to creditors asking them to accept less than the amount owed to them and/or an extension of time to repay debts.
• Sell. All or a portion of the business may have to go before a lender calls in a loan. On the down side, this adds significant time pressure to complete the transaction. As well, prospective buyers will be aware the company is experiencing financial troubles. While these issues will affect the price and the structure of the deal, moving all or part of the business to new ownership preserves value.
The success of these solutions relies on acting quickly and providing management with an opportunity to resolve fundamental issues. Management teams that successfully refinance, restructure or sell use timely, detailed financial information to produce realistically optimistic projections. After all, hockey sticks don’t win financial competitions; they only win hockey games.
Christopher Porter is a vice-president in the transaction advisory services and financial restructuring practice of BDO Canada Ltd. (www.bdo.ca). Call (416) 369-3062 or e-mail firstname.lastname@example.org.