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A Primer On Restructuring Your Company's Finances
A Primer On Restructuring Your Company's Finances
BUSINESS LAW
Company’s Finances
by Mike Harmon
June 09, 2020
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Government responses to the Covid-19 pandemic have closed down a significant portion
of the global economy, creating severe liquidity problems for many companies at a time
when the corporate sector is historically highly leveraged across the board. So while the
2001 and 2008 economic downturns put only a relatively limited number of companies
under serious cash-flow pressure — those that were both leveraged and whose earnings
were sensitive to the economic cycle — the current crisis has left swathes of companies
scrambling for cash.
Plan A for most companies has been to operate within the constraints of their existing
financing agreements, which in practice means drawing as much as they can from their
existing revolving lines of credit. However, when this and other resources run dry, many
companies will find that their liquidity needs, combined with continued earnings pressure,
will render their current highly leveraged capital structures untenable, especially with a
gradual reopening of the U.S. and other economies. A lot of companies, therefore, will
have no choice but to restructure.
Renegotiating financial contracts helps firms short of cash in two ways. First, it allows
them to realign the financial and contractual burden associated with their financial
obligations so that it matches their current values and cash flows. Second, it facilitates the
infusion of new capital into the business.
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Book The role of the board of directors in this
$22.95 undertaking will depend on whether the
View Details company is solvent or not. If it is solvent, the
board will emphasize the interests of
shareholders, but if it is insolvent, the board
must consider the interests of creditors.
Either way, a key objective for the board is to
maximize the value of its enterprise, which may include facilitating access to the liquidity
a company needs to fund viable operations and projects.
From the perspective of a company’s creditors, those at risk of losing capital can mitigate
those losses in three ways: They can permit the company to take actions that maximize
enterprise value; they can demand higher share of that value; and they can insist that the
form of this share be structured so as to improve the likelihood that they recover or
maximize their investment over time.
Wherever a party finds itself in a restructuring, it will access the same collection of tools
to accomplish its objectives. I call this group of tools the “restructuring tool set,” and I will
describe each of the methods here. I am not offering a complete list, but these are the
most effective tools that a company or its creditors can use to change the financial
position. Also note that these tools as described are those that are applicable under U.S.
law, but many international jurisdictions permit similar ones.
The tools fall into two categories: those that can be used in an out-of-court context and
those that take place in the context of an in-court process.
Out-of-court Restructuring
Out of court restructurings are typically less expensive than in-court ones, but they
usually require close to unanimous consent from creditors on material changes, such as
those to the interest charged on debt or its maturity. This agreement can be difficult to
obtain, especially when interests of shareholders and debt-holders conflict, which they
may often do. They are more likely to succeed if creditors perceive that the alternative to a
negotiated deal has adverse consequences for their claims. The principal tools of an out-
of-court restructuring are:
In-court Restructuring
If a company and its creditors cannot reach agreement for a restructuring outside of court,
they may have to pursue the transaction inside a Chapter 11 bankruptcy process. While
bankruptcy is more expensive than an out-of-court agreed restructuring, in circumstances
where the debt holders cannot agree quickly on a solution, Chapter 11 offers more scope
for keeping the business afloat. The key features specific to Chapter 11 restructurings are:
People often think about restructuring as just a different way to slice up the proverbial pie,
which, to mix metaphors, results in it becoming a tug of war between companies and their
various creditors, as each party tries to increase its share at the expense of others. But in
many cases restructuring the right (liabilities) side of the balance sheet can actually
increase value on the left (assets) side of the balance sheet by
Relieving or deferring debt obligations that may stifle investment and growth;
Enabling the infusion of new capital into the business;
Allowing the termination of unprofitable contracts; and
Facilitating the sale of unproductive assets and the redeployment of resources into more
productive areas.
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The benefits accrue not only to the company: Creditors can also benefit from a
restructuring that improves the value of the assets on which the they have claims. In
entering a restructuring process, therefore, I would urge all parties to use it for mutual
benefit by focusing, where possible, on those areas where there is a basis for a more
sustainable — and potentially more valuable — business going forward, expanding the size
of the pie for the benefit of all stakeholders.
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Mike Harmon is the Managing Partner at Gaviota Advisors, LLC; his previous experience includes over twenty
years as a special-situations investor with Oaktree Capital Management.
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