Among the chief concerns of businesses in chapter 11 is the need to generate sufficient liquidity to fund ongoing operations. In many instances, under-performing business units require more cash than is generated by the core business. In still others, the core business itself (at least temporarily) operates in a cash-flow negative environment. Compounding these issues, many debtor-in-possession loans do not provide more than a short-term solution to these liquidity constraints. For this reason, cash-generation techniques continually warrant attention from company management and bankruptcy practitioners alike. After all, any attempt to address the underlying business issues that precipitated the chapter 11 filing in the first place must be predicated on creating enough financial "breathing room" to implement the turnaround.

To create liquidity, restructuring advisors use a variety of techniques, ranging from less invasive tactics such as exerting control over cash disbursements, lowering levels of on-hand inventory, and focusing on the collection of receivables to more drastic strategies like shutting down under-performing business units, reducing head count and selling non-core assets. Under the proper circumstances, a combination of the above strategies can effectively address these cash constraints. One primary focus of the financial advisor is therefore to recognize the appropriate combination of these remedies given the client dynamics and financial/operational constraints. For example, it may not be appropriate (or even possible) to enforce strict disbursement limitations when the company's primary vendors are sole-source suppliers. Likewise, head count reductions may have little or no impact on cash in a capital-intensive business.

The following discussion focuses on the factors affecting the viability of one of these cash creation techniques: an asset-sale strategy. Particular emphasis is then placed on maximizing sale proceeds, minimizing time delays (which can be significant) and addressing other considerations that may hinder the sales process.

Viability of an Asset-sale Strategy

Most financiers recognize the benefits of monetizing under-performing or unused assets. However, given the time delays that often occur and the prevalence of distress pricing, undertaking this strategy in chapter 11 is not always the best use of company resources. Thus, before initiating a full-scale asset sale process, it is imperative to complete an honest internal evaluation of the subject assets relative to both the company's short- and mid-term cash needs and its resources available to manage the process.

The first aspect of this evaluation should focus on the overall marketability of the assets, particularly under different sales scenarios. For instance, a piecemeal liquidation of assets via auction or outright sale to a liquidator may be able to provide fast cash (relatively speaking), but the ultimate proceeds may amount to only a fraction of the fair value of the property. Likewise, given prevailing market conditions (i.e., a glut of similar assets in the marketplace or a shift away from the specific technology used in the assets), there may not even be a viable market for the assets.

A second facet of the evaluation should center on matching estimated cash proceeds against the company's short- and mid-term cash needs. If the assumed proceeds do not effectively meet these cash obligations, the asset-sale strategy alone will not work. Under this scenario, the advisor must decide whether to temporarily abandon this strategy in favor of a more lucrative one or to use this strategy in combination with other techniques. It is important to note that concurrently undertaking a variety of cash-generating strategies can require additional resources and can hinder the focus and success of each individual approach.

A final factor to consider in the self-evaluation relates to the identification of alternative internal uses for the assets and other opportunity costs. If retaining assets could prevent certain necessary capital expenditures, then the sale probably does not make sense. Too often, companies sell fixed assets for far less than they are worth only to discover a few months later that they will need to spend full price for similar equipment needed within another division. On the other hand, the expenses associated with retaining certain assets sometimes exceed the benefits from finding these alternative uses. For this reason, it is crucial to reflect on the various types of asset holding costs (e.g., rent, maintenance, utilities, security, etc.) when determining the viability of an asset sale.

Maximizing Sale Proceeds

Assuming an asset-sale strategy is a viable option for generating liquidity, one's primary goal becomes undertaking a game plan to maximize the sale proceeds. The first step in this process involves developing reasonable expectations for the eventual proceeds. A number of value indicators are often available to aid in this process. The most basic of these indicators (and probably the least accurate) is book value. Book value is merely an accounting convention reflecting the original cost of the asset less any accumulated depreciation expense. It does not reflect current market conditions and is skewed by depreciation methods that are often undertaken to limit the company's tax exposure or to manipulate earnings. A more accurate value indicator is an appraisal of the subject property, indicating either its fair value or liquidation value (or both). While they are more accurate than book values, appraisals are often not ideal indicators of value, either. This is because appraisals quickly become outdated, particularly if conducted well before the chapter 11 filing. Also, it is important to recognize that appraisals are often completed for specific business purposes (particularly in the case of "value and use" appraisals) that can skew their results. Finally, though appraisals and book values can provide important insight into the values of certain assets, even more relevant value indicators can be obtained through discussions with asset brokers/agents or by attending auctions for similar equipment.

The second step in maximizing sales proceeds is identifying the most likely type of buyer. While almost all buyers are anxious to take advantage of "distress discounts," an equipment liquidator is not likely to offer nearly as much for equipment as an end-user. For this reason, one should aggressively seek out all possible end-users. Brokers can help in this search, and some non-traditional buyers (i.e., landlords, competitors, neighbors, vendors, etc.) should also be contacted directly. In addition to avoiding the substantial fees charged by the middleman (i.e., the broker or the liquidator), selling directly to these end-users may generate proceeds closer to fair value.

The third and final step toward maximizing sales proceeds involves managing the "fire sale." Unfortunately, end-users do not always present themselves during the original solicitation for bids. Hence, the decision must be made as to whether or not to abandon the sales process or to proceed under less-than-ideal circumstances. When proceeding, one must recognize the full slate of options available, including (1) selling the property directly to a liquidator, (2) hiring an auctioneer to sell the equipment piecemeal (see the Auction Basics chart below for various auction types), (3) engaging one or more brokers to sell the property on the company's behalf or (4) petitioning the court to lead an auction during a scheduled bankruptcy hearing. Any of these options can work effectively. The first option is the quickest to complete but often generates the lowest recovery, as it requires the liquidator to front its own money (not always an attractive option for them). The second and third options can also be effective, but they can take longer to complete. Also, there may be no guarantee that all assets will in fact be sold, or that they will be sold at a specified price. Finally, the fourth option can be both expeditious and profitable. However, not all bankruptcy court judges are willing to supervise such a process. Also, given the limited amount of time available in front of the judge, this option requires more preparation and organization on the company's part in advance of the auction.

Limiting the Time to Sell

While asset-sale strategies can often generate substantial liquidity for a chapter 11 company, the process can often take several months to complete. There are many steps required to finalize the sale, and each step can take a considerable amount of time (often, the length of each step is beyond the control of the company). The first step in the process involves the solicitation of bids. To shorten the time in this stage, it is important to contact all prospective buyers early and often. Management may be inclined to contact end-users first and await their responses before proceeding with brokers, agents and liquidators. However, if no bids are collected after two or three months, they will be essentially starting over with the alternate (discount) buyers. Running solicitations to all prospective buyers concurrently can help avoid these timing delays.

The next step in the process involves the evaluation and renegotiation of bids. One method for limiting time spent on these activities requires some forethought during the solicitation process. By simply developing and distributing a uniform term sheet (along with consistent guidelines for providing proof of the bidder's ability to pay) to all prospective buyers, one will be able to easily compare bids and facilitate a fair negotiation. Likewise, once the appropriate bid has tentatively been approved, it is important that simple and standard contractual terms be shared with the prospective buyer to alleviate unnecessary contract disputes. Given the overall supervision and sale approval required by a bankruptcy court judge, there is scant rationale for preparing long, complex and overly restrictive contracts.

The third step in the sales process includes providing adequate notice to all other bidders and parties-in-interest indicating the company's intent to finalize a sale. There is not much variability in the notice period (it must be at least 30 days in most jurisdictions); however, it may be reasonable to provide this notice even before all contractual terms have been finalized. This will effectively start the clock sooner (upon acceptance of a reasonable term sheet).

In outright and brokered sales, the fourth and final step of the process occurs with the court approval hearing and the subsequent closing of the sale. Clearly, the ability to effectively support and present the business reasons for the asset sale in front of the bankruptcy court judge is paramount to gaining quick approval. In addition, to avoid closing delays, it is imperative to agree in advance (with the buyer) on a scheduled closing date and the means for collecting sale proceeds. If at all possible, escrowing these funds in advance of the hearing is preferable, as this will generally prevent delays caused by the buyer's cash constraints.

The final step when hiring an auctioneer does not occur until the assets are finally sold and funds are passed through to the company. Even after the court approval hearing, this process can be lengthy. However, delays can be easily avoided by including constraints on the timing of the auction within the auction services contract (perhaps agreeing that all assets will be auctioned within 21 days after the approval hearing).

Other Considerations

Maximizing sale proceeds and limiting the amount of time to complete the sale are the two primary considerations when undertaking an asset sale strategy. A few additional considerations also warrant attention in bankruptcy cases. These issues can impact the ultimate sales proceeds, the timing of the asset sales and the ability of the company to use the proceeds to fund operations. The first issue involves collateral constraints. To the extent that the subject assets are fully or partially secured by outstanding debt, the ultimate cash proceeds may be required to repay the underlying loan. Therefore, it is important to review collateral agreements and to hold open discussions with lenders before assuming that a comprehensive asset sales strategy will generate liquidity.

Another consideration within the asset-sales process relates to the differences between selling real and personal property. In most cases, the sale of real property can be more problematic. This is because buildings and real estate are often fraught with issues not relevant in the sale of equipment, such as disputes over property boundary lines, environmental liabilities and zoning restrictions. While advanced preparations can be undertaken to address these issues through securing up-to-date surveys and property inspections, such issues will tend to lengthen the time to sell real property. Further delays can also occur because notice to all constituents cannot be made until all major contingencies are resolved. While this provision is relevant for both personal and real property, it is worth pointing out that more contingencies are typically included in real estate contracts (i.e., financing contingencies, due-diligence periods, etc.).

A final challenge facing sellers of assets in chapter 11 stems from the need to demonstrate (in court) that the highest and best offer was received. It is not uncommon for new bidders to wait until the ß363 hearing to present their higher offers for the assets, thereby winning the bid. While accommodating these overbids can benefit the estate, it also tends to discourage advanced bidding on the assets. A few tactics can help address this issue. First, break-up fees can be included in the asset-sale contracts, forcing new bidders to raise their bids by at least the level of the fee. Second, incremental overbids can be required, effectively passing along similar break-up costs to the new bidder. Finally, one may be able to avoid the approval hearing altogether by following detailed bid procedures pre-approved by the court.

Conclusion

Among the more challenging aspects of the asset-sales process is the search for prospective buyers of the individual assets. Many practitioners are already discovering that the development of the Internet can expedite this matching of sellers and buyers. Yet, even with technological advances, the steps along the asset sales process remain virtually unchanged. A viability assessment still must be completed, steps still need to be taken to maximize proceeds and minimize time delays, and the practitioner still needs to be aware of the various obstacles that can prevent a successful sale. With an adequate amount of forethought and preparation, an asset-sales strategy can effectively create the liquidity needed to run the business and (hopefully) fund a viable turnaround effort.

Footnotes

¹ Jon Slatkin is an associate at Jay Alix & Associates. He has extensive experience preparing business and asset valuations for acquisitions, divestiture, litigation and financial planning purposes and has worked in the manufacturing, financial services, health care, hi-tech and entertainment industries. Return to article