Business health now means access to capital
15 April 2020
Uncertainty is the very condition to impel man to unfold his powers. – Erich Fromm
Business operational health used to be more of a technician’s game. The best communicators and data collectors used to produce the best performance. But now, in the midst of the near-total meltdown of our economic systems as the result of the Covid-19 pandemic, business health is reduced to first principles – meaning, access to capital. To survive into the post-pandemic world, businesses, their lenders and their investors need to minimise loss and maximise long-term financial stability in this volatile and unprecedented environment.
It is a fact that businesses, even robust businesses, must consider the adverse impact on operations and cash flow resulting from the steps taken to slow the spread of the virus and ‘flatten the curve’ of new cases. Many businesses are closed; others are suffering disruptions including reduced hours of operation from government restrictions; while still others are confronted with supplier or customer delays. Regardless of sector, the inability to generate adequate cash flow jeopardises the ability to meet obligations to lenders, creditors and investors.
The first wave of ‘business speak’ focused on how businesses could either insist on or repudiate contract obligations. Google force majeure, and you will find more pieces written about this ancient French doctrine over the past month than over the past 50 years combined. But any company that thinks it can survive these times through traditional litigation-style behaviour will need to find more tools for its toolbox. Mirroring what is happening in society more broadly, business actors will have to learn to behave collaboratively to maximise our recovery.
Survival and loss mitigation: 1. new projections
While no one really wants to look, it is critically important that companies recast operating cash flow projections. This includes revising assumptions, forecasts and business plans that reflect the new reality facing the world. It is important to prepare current projections that consider the best and worst cases for the next few months and longer. These may necessarily require frequent recasting as well.
Revising projections that consider the current environment is an important part of making good operational and management decisions. While companies will now likely need to update projections more frequently to keep up with the near daily ramifications of the outbreak, it is important to keep thinking about best and worst cases. If there is a worst-case scenario that suggests a need for a company or a valued business partner to initiate a restructuring process, the sooner steps are taken to start the restructuring process, the more options the business will have. A proactive approach is critical, especially in these fluid situations. Management that hides its head in the sand likely will not survive. Hiring experienced legal professionals and financial advisors early can provide credibility in dealing with lenders, trade creditors and investors and preserve enterprise value.
2. Develop a new financial and operating plan.
Triage is important. Often businesses are adept at managing operations in times of stress. However, few companies have ever faced the dramatic, escalating crisis now present. Companies have little choice but to pivot meaningfully and strategic planning is key to survival. This planning has to address the new reality reflected by revised and updated projections and should include:
- Protecting working capital: this includes an inventory of existing working capital, drawing on existing lines of credit and developing and implementing a cost reduction plan to achieve rapid positive cash flow benefits. Cash is king and must be preserved.
- Legal and business review of existing credit facility documents: it is important to review loan and bond indenture documents thoroughly with a particular emphasis on non-monetary covenants and those monetary performance covenants that could cause a default. If covenant breaches are possible, it is important to be proactive and to develop a strategy to discuss standstill and waiver agreements with the lender and determine whether covenant breaches create cross defaults in other company obligations. To the extent a company has multiple levels of financing, it is important to review the inter-creditor agreements and include all tiers of lenders in discussions because if covenant relief is necessary, it will likely take a collective and collaborative effort.
- Identify any collateral that could secure additional financing: seeking additional financing may not be feasible given the current environment. That could change, however, and monitoring federal and state government relief initiatives is vital. However, to the extent a company has unencumbered assets, additional liquidity may be easier to procure. It is important to identify assets that might be available to secure additional financing including real property, inventory and account receivables. Furthermore, securing new guaranties from principals or other entities in the corporate enterprise may help to secure additional financing. To the extent existing loan documents require lender consent to incur additional indebtedness, consider requests to lenders sooner rather than later.
- Working with a professional legal and financial advisor team to open lender communications: Many times companies that need to obtain additional financing on an emergency basis think that engaging professionals to assist is a sign of weakness or requires expenditures that the company would prefer not to make. In fact, involving professionals in the process provides significant credibility to the ‘ask’ or request to lender for relief. Lenders and investors may be more willing to respond quickly and positively if provided with information that has been reviewed by the company’s legal and financial advisors. Attempting to save money by not hiring a professional team can jeopardise the ultimate success of discussions with lenders and investors.
If there are existing covenant breaches, a legal and financial team can guide proposals for relief. Many lenders will require appointment of financial advisory teams and are not comfortable negotiating with a company without the assistance of counsel. It is also very important that a company’s board be involved and approve the requests for financing and the strategy to address covenant noncompliance.
Lastly, a company usually has several avenues for relief available – standstill and forbearance agreements, amendments, extensions, restructuring, increased indebtedness – all of which may provide the needed relief. It is more efficient to start the conversation with existing lenders sooner rather than later. In this environment, legal and financial teams will need to be open to suggesting new and creative options. The growing level of financial stress and distress is expected to make lenders more receptive to new options because lenders have to manage defaults to preserve value.
3. What if maintaining existing financing is not viable
Once management is aware of its company’s inability to perform, management must work with its board to establish strategies for each of its consistent groups, including, employees, lenders, trade creditors and suppliers, customers and investors. This strategy must also include developing communication plans for each of these groups. Professional advice is also necessary to manage financial disclosure required by regulators and oversight bodies.
Retaining legal and financial advisors is critical to address an impending default or forecasted inability to perform on contracts or other obligations. Management must have a strategic plan in place to address these serious issues and outside counsel and financial advice is necessary to consider options, minimise risk and maximise value. Management operating in a normal environment is not usually confronted with these challenges. Outside advice is critical to a board’s exercise of its duty of care to the company and its stakeholders. A board’s awareness of fiduciary duties based on experienced professional advice can avoid serious consequences down the road.
While management often is very skilled at ‘business as usual,’ it is important to recognise that for most companies facing the current crisis outside help is needed in this abnormal time. It may also be appropriate to consider a crisis management team and a government relations team depending on the industry sector and whether the business is heavily-regulated. Multi-disciplined professional teams are skilled at generating options and finding creative solutions that add value.
Once the board approves a strategic plan, initiating discussions with lenders and other stakeholders will require financial disclosure including projections. Lenders will need to verify financial and operating information in order to consider requests regarding covenant relief, standstill and forbearance of defaults and restructuring the debt. The plan will likely include restructuring strategies.
It is important to determine what ‘asks’ or requests for relief of lenders are necessary to allow the business to continue to operate in this unpredictable environment. These ‘asks’ include what is needed to avoid default on short and long-term financing obligations and what is needed to maintain relationships with vendors and suppliers. This includes ‘asks’ that reflect reduced operations. Relationships with lenders, investors and other creditors can be more easily maintained if communication is open, candid and if there are professional advisors helping the company to determine what “asks” are likely to be successful.
Rewriting the playbook
This article of course focuses on the private capital markets solutions to capital shortfalls. Economic stimulus funds will likely also form an important part of many companies’ survival strategies – sometimes acting separately from private capital solutions, and sometimes working to strengthen them. It is likely that this crisis will rewrite the playbook for restructuring. It is clear credit providers and companies, in order to survive, have to be united in focusing on preserving value until such time the ‘new normal’ economy emerges.
Karol Denniston, Sarah Rathke and Peter Morrison are partners at Squire Patton Boggs