When the "technology bubble" burst in the spring of 2000 and the capital markets closed their doors to emerging growth and technology businesses, strategic thinking by management and venture capital investors failed to keep pace with rapidly changing conditions. Hopelessly optimistic entrepreneurs continued to believe that their own "truly unique" business plans would attract capital and that corporate downsizing and other cost-cutting efforts would send the wrong message to employees, investors and the marketplace. However, meaningful new capital was nowhere to be found. When "new economy" executives finally became frustrated by their inability to raise money and were faced with diminishing cash resources, they began to seek help from turnaround professionals. Unfortunately, their failure to act quickly left many emerging growth and technology businesses with few options beyond liquidation.

Venture capital investors, boards of directors and senior executives frequently wait until too late in the game to call in legal experts and other professionals with the financial and turnaround experience to help avoid fiscal ruin. Experience with emerging growth and technology companies has created a new breed of lawyers who can help a struggling business quickly evaluate the viability of its businesses, shed non-core assets, restructure debt, obtain new financing, communicate with major stakeholders and, ultimately, to realize the "going concern" value of the enterprise. However, warning signs are too often ignored by executives who are overwhelmed by the difficulties associated with operating a distressed business. Even a short delay in recognizing or responding to signs of financial trouble will severely limit the options available to reorganize or maximize the value of an otherwise viable business.

Evaluating the Viability of a Business and Exploring Strategic Alternatives

The first and most critical task to be performed in the context of a corporate turnaround is an objective assessment of whether a viable core business exists, and the extent to which viability depends upon an infusion of new capital. Generally, existing stakeholders (particularly existing management) are unable to objectively assess viability without the insight and perspective that an experienced turnaround professional may offer. The decision to invest in new products, discontinue certain operations or sell non-core assets represents "do or die" issues for companies on the brink of insolvency. Unless these decisions are made dispassionately by professionals who have a realistic view of the enterprise and the economic environment in which it is operating, opportunities to save the business will be lost. Without sound advice from experienced insolvency counsel, even the best business decisions can result in financial disaster if they are implemented using the wrong legal structure.

For example, service-related businesses can often accomplish a turnaround by downsizing and consolidating their operations, laying off employees and negotiating termination arrangements with landlords of closed offices. In these situations, there is no need for the company to retain an investment bank or a large management consulting firm. Rather, a successful downsizing may be accomplished with the assistance of counsel and a real estate advisor. By engaging counsel early in the turnaround process, companies can avoid hiring other professionals whose skills are incompatible with the chosen course of action.

There are also a variety of non-bankruptcy alternatives, including secured-party sales and assignments for the benefit of creditors, that can be used quite effectively to sell or recapitalize a struggling business. During the last few years, we have seen an alarming number of liquidations involving businesses that could have been saved if either company counsel or counsel to one or more investor groups had understood or been willing to explore viable non-bankruptcy alternatives.

Financial Forecasting, Conserving Cash and Disposing of Non-core Assets

Simultaneously, with a review of the company's existing business prospects, management must identify and dispose of non-core assets, cut costs, conserve cash and establish an accurate cash-flow forecasting model and reporting system. Because financial projections are the basis upon which most "do or die" decisions will be made during the course of a corporate turnaround, precise forecasting models and timely reporting of the company's ongoing performance is crucial. Any material flaw in a company's financial model, particularly its cash-flow forecasts, that is not immediately detected through regular variance reports can cripple the effort to save an ailing business.

Corporate executives frequently misunderstand the contractual or statutory rights of their investors, lenders, vendors and employees, each of which can have a profound impact on cash flow during a period of insolvency. Legal considerations must be taken into account when financial models are being prepared for the purpose of evaluating viability and assessing strategic options. Cash-flow forecasting is also a useful tool to help management evaluate the propriety of current expenses. Expenses that make good sense for an expanding business may represent corporate waste for a business that is suffering the ills of economic contraction.

Even if creditors are initially persuaded by management's presentation, all credibility will be lost when it becomes apparent that the company cannot meet the expectations that it has established through its financial projections. It is always better to outperform conservative financial projections than to constantly explain negative variances.

The judicious use of cash and other liquid resources is also the highest priority during a turnaround. Quite often, distressed businesses continue to service senior secured debt and make equipment lease or other payments to creditors that have refused to engage in meaningful restructuring discussions. While most business executives understand that "stretching payables" generates working capital, it is often more difficult for them to understand that non-payment of senior secured and other institutional debt may be the best way to conserve cash resources, while getting the attention of a major creditor with whom restructuring discussions must be had immediately. If the decision to stop paying institutional creditors is handled and communicated with care, it can expedite discussions with major creditors.

Promptly identifying and disposing of non-core assets also is a central component of any successful corporate turnaround. Non-core assets, including long-forgotten bank accounts, company-owned real estate or overfunded pension plans, can help generate badly needed cash. Non-core assets can also include poorly performing business divisions for which no buyers have or can be found.

Forging Stakeholder Consensus and Implementing a Restructuring Plan

Once a viable restructuring plan or exit strategy is adopted, counsel must help construct the legal framework within which the plan can be implemented with or without the unanimous approval of creditors and other stakeholders. In this regard, counsel must educate management about the consequences of a failure to reach agreement with various creditors and the options (if any) available to force a restructuring of the company's debt, including a reorganization under chapter 11. Only when management fully appreciates all of its options will the maximum leverage be gained during workout negotiations. Similarly, unless creditors recognize the options available to a corporate debtor in chapter 11, they may remain inflexible and unwilling to make a reasonable deal. It is the responsibility of company counsel to trumpet these options as a means of convincing creditors that an out-of-court restructuring is the more desirable approach.

Restructuring an ailing business is a fluid process. In this regard, one must learn to "expect the unexpected" and plan for it. Skilled turnaround professionals temper the expectations of their clients, so that "unexpected" changes will not create an unnecessary distraction or derail a well planned restructuring. Timely financial reporting and careful contingency planning will help a distressed business detect and deal with most financial or operational surprises.

Typically, insolvency counsel is also at the center of discussions with old and new financing sources. Counsel can be an excellent point of access to debt and equity financing sources. The energy and credibility that counsel brings to these financing discussions may well represent the difference between a reorganization of the client's business and a liquidation.

With a little bit of luck and a great deal of hard work, distressed businesses can be reorganized or sold and the value of the going concern preserved. The odds of a successful turnaround are substantially greater if skilled professionals are hired as soon as signs of distress materialize. Denial and delay are fatal conditions for troubled businesses. That is why you should "call me now, not later."

Footnotes

¹ Chad Dale is a partner in the Business Reorganization and Bankruptcy practice at the Boston law firm Gadsby Hannah LLP. Return to article