Corporate Restructuring: Pitfalls And Opportunities

Sunday, October 4, 2009 - 00:00

Editor: Two years of tight markets and even tighter credit have put corporate downsizing, liquidity problems and even bankruptcy in the news. Can restructuring give business executives real control over their companies' trajectories?

Goldstein: Restructuring can be the best option - and sometimes, the only viable one - for a company that has taken too many hits from an extended downturn. Still, it helps to remember that even in the best of times, a company has to work with the resources it has and the market as it exists. In tight economies, it is even more important to be proactive, to constantly monitor not just your company's performance, but also the health of your competitors, clients and customers, and vendors and lenders. You should have a recovery strategy ready before you actually need one because it's twice as tough to come up with alternatives when you are in the midst of a crisis.

Davis: That's right. A company also misses opportunities when it waits too long to implement substantive change. That's why it's so important to monitor the internal and external corporate environment closely. Let me emphasize that this means more than tracking changes; it means an ongoing, active reassessment of business plans and relationships that guides corporate responses to risks and opportunities.

Editor: Given the state of the economy, I expect that corporate risk aversion is at an all-time high. Doesn't that keep business executives on their toes?

Goldstein: Risk aversion tends to make people very cautious and reluctant to act. However, that is exactly the wrong approach for this economy, where failure to act can be the greatest risk of all. It's no secret that the marketplace is unfriendly to weakened businesses. Corporate decision-makers are expected to recognize when their companies are nearing what is called "the zone of insolvency." Corporate legal departments and outside counsel must be on top of this issue because there are substantial legal ramifications. The company must act swiftly to protect both itself and its creditors from further erosion. Executives who delay restructuring or continue to pile up debt may end up being personally liable to corporate creditors and shareholders - especially if the company ends up in the bankruptcy courts.

Editor: Are there specific warning signs that business executives should be looking for so they can avoid both insolvency and liability?

Goldstein: Loan defaults are obvious indicators, as are operating losses, especially when they continue beyond traditionally slow seasons. But a company needs to look beyond itself, too. If your business depends on a key supplier or vendor, you are tied rather tightly to its health - so watch it carefully. Similarly, when key clients or customers begin to reduce their orders, make frequent last-minute changes to standing orders or fall behind on their payments, be prepared to restructure your business relationships and rethink your projections. Whenever these red flags start popping up in the internal data of any business, we encourage corporate decision-makers to consider restructuring. Delay can be fatal.

Editor: Restructuring business relationships sounds different from the downsizing and outsourcing we usually think about when businesses restructure. Which way is better?

Goldstein: The two strategies are not mutually exclusive. Reworking contracts and revising joint venture and partnership agreements can be crucial to maintaining a positive cash flow and a healthy business. Many companies also need to simultaneously adopt an aggressive "shrink to profitability" strategy that eliminates unprofitable product lines, speculative investments and excess overhead by focusing on core competencies.

Davis: Don't forget that restructuring is not limited to downsizing or cutbacks. In some circumstances, it can include growth strategies, such as vertical or horizontal integration. For instance, if a supplier of key components is struggling, you may want to consider acquiring part or all of the business to ensure that your company gets the supplies it needs. This approach has been less popular during the past 24 months because of the tight credit markets. However, as the economy improves, M&A activity will pick up as strong companies reactivate this strategy and acquire weaker firms that survived the storm.

Editor: These suggestions seem to assume that a company has enough capital or credit to make rather large payments or investments. How realistic is that?

Davis: The current downturn may affect everyone, but some businesses are well-placed to find opportunities. On a pragmatic level, companies need to be more self-reliant than ever. The easy lines of credit just aren't there now, so companies should consider alternatives. Sometimes that means investing in a vendor or reworking agreements so that the terms are more feasible for the company and its clients.

Goldstein: That brings us back to restructuring relationships. Sometimes, recognizing economies of scale can help both the vendor and purchaser. It might be more cost-effective, for example, to change monthly deliveries to weekly or quarterly deliveries. Or, to centralize or decentralize deliveries, depending on what works best. These steps can reduce costs without the need for large upfront cash expenditures. Any business, large or small, can benefit from such strategies.

Editor: You've already described some of the risks that economically stressed companies and their executives face, but you also mentioned opportunities. Tell us about those.

Davis: Restructuring itself is an opportunity to avoid the collapse or liquidation of the company. The risk of failure exists before a decision to restructure is made. Furthermore, I believe it's important to distinguish between restructuring and reorganization. Restructuring involves a significant modification to a company's balance sheet (debt levels and capitalization), which is frequently accomplished through the Chapter 11 process. Reorganization focuses more on a revision of company operations, including product lines, services, relationships and personnel. Reorganization is also a key part of the typical Chapter 11 process. Whether a company needs restructuring or reorganization, a proactive approach is always better. Don't wait until it's too late.

Editor: Many people would say that it's already "too late" if a company has to file a Chapter 11 case.

Goldstein: Chapter 11 is actually intended to offer distressed businesses a chance to reorganize and recover before it's over for good. Some problems are simply too large or complicated to deal with outside of the bankruptcy courts. For instance, mass tort litigation or class actions can chew up a company's time and cash. The Chapter 11 process puts a stop to those litigation matters so the company can focus on its business.

Editor: Do companies get a better deal in the bankruptcy courts than in the open market?

Davis: Troubled companies can get a breather and a fresh start because the bankruptcy court provides an organized forum to resolve disputes and reorganize the business. Bidders for corporate assets will certainly get a more transparent "deal" in the bankruptcy courts. One great advantage for buyers is the increased availability of detailed books and records that can be scrutinized by all parties, including creditors. That last part is very important: creditors play an essential role in Chapter 11 reorganizations, acting as watchdogs to keep away frivolous offers - and to get the best deal! Business rivals often turn out to be the most competitive bidders.

Editor: I thought that companies filed Chapter 11 cases to reorganize and keep doing business, not to sell themselves. Am I missing something?

Goldstein: Reorganization is the goal of Chapter 11, but reorganization can involve the sale of the entire business, or its underperforming divisions or burdensome "assets," including long-term leases. A sale of the business is typically viewed as a successful Chapter 11 because the business enterprise has been preserved, albeit under new ownership. For larger companies, it is often possible to use Chapter 11 to reorganize specific divisions rather than the entire corporation. The sad truth, however, is that not every reorganization case succeeds. When failure occurs, the business is usually liquidated through a Chapter 7 proceeding.

Editor: What's the most common reason that a restructuring or corporate reorganization fails?

Davis: Both out-of-court restructurings and Chapter 11 reorganizations are most likely to fail when corporate executives are too slow in recognizing and responding to red flags that should alert them early on to the need for corporate restructuring. The most successful Chapter 11 cases have a well-planned exit strategy before the case is filed. These companies have moved before their creditors have whittled down their credit lines, capital and credibility.

Editor: Are those red flags you mentioned earlier difficult to see, or do people simply ignore them?

Goldstein: Corporate executives often have a can-do, accentuate-the-positive attitude that has succeeded for them and their companies for years. So, there may be a tendency to simply discount or dismiss bad news until it becomes unfixable. Also, when people are surrounded by a group of inside experts, managers and advisors who have all been looking at the same data and problems for a long time, they may develop a "group think" mentality that is unrealistic or highly biased. It's hard to step beyond one's own experience. That's where a fresh, knowledgeable, objective eye can really help.

Editor: This sounds like a Catch-22. If a company can't see its blind spots, how does it recognize when it is backing into one?

Davis: There are some patterns to watch for, although they may have fuzzy borders. One signal is recurring discussions about problems without a clear action plan or resolution at the end of the discussion. Another is constant modification of action-plan trigger events that simply prolongs the status quo and prevents any action, regardless of planning, from being implemented.

Goldstein: It boils down to this: If a company appears to be in trouble, it probably needed help some time ago. And if it looks like a company will need help down the road, it probably should reach for that help now.

Please email the interviewees at charles.goldstein@protiviti.com or guy.davis@protiviti.com with questions about this interview.