Reorganizing under chapter 11 is a complicated feat at best. When the debtor is a retailer, the challenge is even greater. The vast majority of chapter 11 plans involving retailers are plans of liquidation following the sale of substantially all of the retailer's assets. Indeed, in many cases chapter 11 filings by retailers were not undertaken with the intent of reorganizing an ongoing business, but rather to create a platform to sell the debtor's assets at their highest and best value. As we have pointed out in prior columns, chapter 11 continues to provide the optimal platform for extracting value for both the tangible and intangible assets of retailers.

Assuming that the goal of a retailer is not an orderly liquidation of its assets but instead is the restructuring of its business, what does it take? Here are some things you may want to consider:

1. Debt. Can the retailer incur additional debt to fund its restructuring and exit? The first place you need to look is the liability side of the balance sheet. The strong likelihood is that the retailer is financed in two ways: first, through unsecured credit from its trade vendors, and second, through a mix of secured term debt and asset-based credit facilities. Although there are a number of older large retail companies that continue to enjoy access to unsecured credit from institutional lenders and the public markets, there is a significant trend toward securitizing these facilities and shifting to asset-based lending arrangements. This shift, combined with the consolidation and specialization dynamics in the debt market, creates several new variables to the debt structure. Different in name (Tranche A, Tranche B, Convertible Preferred, Trade Liens, etc.), they all do the same thing: they consume control of the retailer's tangible assets. Moreover, with the advent of new Article 9's "all-assets" security interest and certainly in the context of DIP loans, it is likely the case that the retailer's intangible assets will be encumbered as well.

Unless the retailer has had the foresight to commence its chapter 11 case well before it has reached the point of encumbering all of its tangible and intangible assets, it will be challenged to incorporate debt into advantages that can be used to develop its reorganization plan. Debt is only available as a tool when there are unencumbered assets against which lenders are prepared to lend.

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The best opportunity is likely to result from a strategic partnership or from acquiring the retailer by a strategic buyer.

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The amount a lender is prepared to lend to a retailer in return for a lien against the retailer's assets is called "availability." Whether or not there is quantifiable availability will determine whether debt financing will support a retailer's chapter 11 restructuring. The lower the availability, the fewer options the retailer has in managing ongoing performance and reorganization strategies. Credit managers and the credit-monitoring services they rely on have become increasingly more sophisticated in terms of making real-time assessments of a retailer's ability to incur additional debt. As availability decreases, the retailer will find that its access to unsecured trade vendor support decreases as well. This two-sided squeeze ultimately dooms the reorganization prospects for many retailers.

2. Equity. It will almost always be the case that equity positions must be restructured for a retailer to reorganize under chapter 11. The very nature of balance sheet and income statement performance require it. Public markets and income generation/ cash-flow valuation dynamics challenge the realization of acceptable returns on invested capital. This makes additional equity investment less attractive. By its nature, creating a retailer's balance sheet is a capital-intensive exercise. Today's retailers are increasingly required to make significant long-term investments into infrastructure. Information/logistics technology, human resources and physical plant investments are the capital needs requirements necessary to achieve a successful turnaround and long-term growth and survival. The costs associated with such investments are typically large and require extended timeframes to realize payback. Yet they are an absolute requirement to compete and maximize ongoing profitability. An entity willing to make an equity investment into a retailer today requires a strong stomach and a lot of patience. While the typical ROI pro forma must measure returns over several years, the dynamics of retailing today ensure that operating assumptions will change over the course of several months.

A retailer's performance is driven by efficiency, liquidity and concept. A retailer's short-term results too often dictate strategy. This is especially true in a restructuring where short-term results may dictate the nature of the long-term player's assumptions. Any realistic equity investor must evaluate the delta difference between the retailer's infrastructure requirements and the state of that infrastructure at the time the proposed investment is to be made. When that delta is small, it becomes more likely that a realistic opportunity exists for reorganization supported by new equity. Unfortunately, in most cases, struggling retailers are forced to forego capital investments in favor of shorter term fixes. The equity market demands immediate results. In an effort to deliver those immediate results, retailers must often sacrifice their long-term viability. The cost of remedying this situation comes in the form of an even more elongated and increased investment horizon with a concomitant negative impact on ROI and a reduced prospect that equity will be available to support the retailer's reorganization.

3. Strategy. As the foregoing discussion highlights, the driving issue for struggling retailers facing the prospect of a bankruptcy court-supervised restructuring is how short-term decisions affect long-term outcomes. The ever-widening gap between good and bad retailers continues to produce competitive and marketplace forces that make a successful reorganization a daunting task. The market place is vicious, ever-changing and competitive. The time frames for correction are long and uncertain. Chapter 11 allows the retailer to close unprofitable stores and exit difficult markets. However, fixes of this nature only staunch the bleeding. In and of themselves they rarely address the fundamental requirements for long-term survival and prosperity. Strategic initiatives may buy time. Alone, they will not buy ultimate success.

Is there an answer to our question? It's a matter of resources. It is reasonable to expect that for any troubled retailer, correction to liquidity issues, efficiency and concept are necessary, with each just matters of degree. In evaluating a retailer's prospects for reorganization, consideration must be given to how the retailer gains access to the resources necessary to allow it to effectuate the turnaround it desires. In this column, we have discussed turnarounds predicated on increased debt, increased capital investment and improvement to ongoing performance. Each of these potential solutions poses substantial challenges, and their pursuit substantial risks. They are all long-shot bets that at the end of the day may only make sense for out-of-the-money constituents to play.

Where then can you find the resources necessary to reorganize a retailer? The best opportunity is likely to result from a strategic partnership or from acquiring the retailer by a strategic buyer. Although a strategic alliance or acquisition does not ultimately result in a classic reorganization, it provides the best opportunity for the preservation of value and long-term survival. The troubled retailer usually brings to the table a melting pot of the good, the okay and the ugly. The addition of the strategic partner or buyer's new resources further leverages the good, perhaps makes the okay better, and depending on how the entities are joined, may absorb the negatives of the ugly so that they do not become the predominate dictator of short-term strategies and long-term results.