The Ethics and Thoroughly Rational Approach to Restructuring a Failing Business
– By Gary Nacht, Owner of Synergy Enterprises, LLC
Eliminating business debt. At first, it might seem to imply “a business not paying what it owes.”
It does not.
What debt elimination refers to is what must be done ethically and rationally when a business no longer has the resources to pay what it owes.
In the context of insolvency and default, business debt elimination can be understood as a benefit resulting from an alternative form of business asset liquidation that preserves underlying business value, operations and jobs.
Business owners are generally ethical and honorable people who, by their nature, are compelled to meet their obligations. When they can, they most often do.
However, the reality is that every year approximately 180,000 businesses file for bankruptcy and many thousands more fail to meet their obligations and face insolvency.
The vast majority of businesses that fail under the burden of unsupportable debt and are liquidated in the bankruptcy system still have underlying core operational value that otherwise could and should have been preserved—along with the associated jobs and economic
activity.
Even more irrationally, approximately 75% of Chapter 11 filings fail to reach a successful discharge. The inefficiencies and costs of multiple objections and extended legal proceedings make it almost impossible for the owner or CEO to complete the bankruptcy plan successfully. The double bind created for insolvent owners positions them between the trap of stacking new debt on the one hand and facing a bankruptcy system which fails to preserve owners or businesses the vast majority of the time on the other.
“We see distressed companies a lot . . . that are underwater with more debt than they have value. Often times the underlying company is good…It’s just due to some bad decisions in the past that they’ve accumulated too much debt and can’t support it.
If we eliminate that debt, it would be a tremendous benefit to those companies and everyone involved.”
– Greg Carpenter, M&A Business Advisor
⠀⠀ Preserving Value is Possible
With so many thousands of businesses being liquidated, all of that underlying business value is being needlessly destroyed on a massive scale along with all of the jobs and economic activity associated with it.
This destruction is the legacy of a failed bankruptcy system and the irrational means of liquidating business assets that stems from it. It is a deep and hidden tragedy in our economy. But it doesn’t have to be.
Business debt elimination is both the process and result of a far more rational means of liquidating business assets that preserves the core operational value of a business in distress or default while preserving jobs and continuity of operations.
Reorganization Creates a Win-Win for all Parties
So, what is business debt elimination? In short, it’s an alternate means of liquidating business assets at the point of failure. Instead of liquidating assets at auction (and destroying the core value of the business), assets can be liquidated into a purchasing entity, preserving and passing through going concern value.
It’s a far more rational and ethical means of liquidating those assets at the point of insolvency.
“These companies still have some fundamentally sound business ideas. And, if you care about the employees, this is a way to reposition those companies to perpetuate those jobs.”
– John Howe
– John Howe
⠀⠀ Business Transition Strategies, NHBS
UCC Article 9 Reorganization
To understand this process requires an understanding of Article 9 of the Uniform Commercial Code. This provision is designed for the protection of first position secured creditors—in short, the bank.
At the point of insolvency or default, it allows the senior creditor to transact (liquidate) their collateral in a private, out-of-court sale in order to recover what they can. Importantly, it also eliminates all subordinate liens and obligations. This is to the creditor’s benefit because, in order to transact on their collateral, a potential buyer requires assurance that they are receiving those assets free and clear.
In short, UCC Article 9 creates the means for the first position creditor to sell their collateral efficiently. But unlike in bankruptcy, this collateral does not need to be sold off at auction.
So why is the Article 9 reorganizational transaction not understood more broadly? The simple answer is because lawyers are trained in bankruptcy and lenders are trained in scheduling new debt.
However, when billions of dollars’ worth of economic activity and business value are being destroyed needlessly every year, along with thousands of jobs, it’s incumbent on every owner and advisory professional to understand the value-preservation afforded by an Article 9 reorganization.
“I was really surprised to learn that this process has something in it for everybody—including the second level of lien holders that actually don’t get paid on their liens—but because they’re going to preserve the ongoing business in a new entity, they can keep the customer.”
– Greg Carpenter
⠀⠀ M&A Business Advisor
Preserving going concern value through an Article 9 liquidation into a purchasing entity benefits the business owner by circumventing bankruptcy. Additionally, performance-based incentives can be allocated from the purchaser back to the distressed seller to create a path to exit successfully. Beyond the benefit to distressed owners, a liquidation that preserves ongoing concern value benefits other parties, including secured creditors and vendors that would otherwise see the debtor’s assets depleted by the traditional bankruptcy process.
- The first-position secured creditor receives their valuation of the collateralized assets without the time, cost and expense of the auction process.
- Subordinate creditors are dealing with toxic assets on their books at the point of insolvency. When the first position creditor removes subordinate liens from underlying assets through an Article 9 short sale, subordinate creditors can write those toxic assets down efficiently while taking advantage of the tax write-offs associated with their failed investment.
- Vendors, who would have taken a loss on outstanding obligations, may benefit by establishing a relationship with the purchasing entity, rather than losing a business relationship as well.
Rethinking Business Debt and Insolvency
Simply put, business debt elimination results from the ethical and rational process of preserving value and creating the best possible outcome for all parties in the context of default.
The Article 9 short sale transaction will necessarily mean an ownership change. For the distressed owner, however, this offers a far better alternative to seeing the core operation destroyed altogether, along with incurring the costs and negative results of a bankruptcy filing and personal liquidation.
Because the core operation is preserved, owners can negotiate an opportunity to earn from the new purchasing entity via a form of employment or consultancy agreement, as part of an incentive structure affording them a path to resolve all personal guarantees (an additional benefit to subordinate creditors). At the same time, this path can uniquely allow insolvent owners to meet their ethical obligations to their employees. And when the core operation is preserved, so is the possibility of earning re-entry into an ownership position in the future.
“I recognized the value immediately. An Article 9 restructuring allowed the business owner to get out of a bad situation. When everybody wins, that’s the best model.”
– Troy Tucker
⠀ Blue Sky Business Resources/Committee Chair, M&A Source
A Greater Good
Business debt elimination can’t be understood solely from the perspective of the benefits to the insolvent owner, although there are many; or even from the perspective of the benefit to creditors. There is also a greater good. Too many jobs and too much economic activity are at stake. Owners, lenders, employees and our nation as a whole must re-conceive how business assets are liquidated at the point of insolvency. The potential economic stimulus offered to the economy as a whole can’t be overstated. The well-being of owners, lenders, employees, and our role in a global economy depend upon it. This is the better way.
About Synergy Enterprises
Gary Nacht, principal of Synergy Enterprises, has been acquiring and advising distressed and underperforming companies for over 25 years, from start-ups to over $1b in revenue across a diversity of industries and channels. His turnaround acquisitions include Northern Reflections (a $100 million Toronto-based retail women’s apparel chain), AmerTac, Inc., (a $60 million New Jersey-based designer and distributor of home lighting products and accessories), GPX, Inc. (a $180 million St. Louis manufacturer and distributor of consumer audio/video products), Gemini Industries (a $180 million NJ-based manufacturer and distributor of Philip’s-branded consumer electronics) and Kmart Canada (a $1.2 billion Toronto-based big-box discount retail store chain). His specialties include:
- Strategic business planning and financial modeling
- Streamlining operations
- Rationalizing corporate structures, overhead and operating expenses
- Contract negotiations with suppliers, lenders and other key stakeholders
- Increasing gross and net margins
- Upgrading data capture, access, analysis and KPI reporting
In August 2020, Synergy Enterprises formed an alliance with Second Wind Consultants to provide business owners and their trusted advisors a single-source solution for restructuring companies in distress by simultaneously tackling operational restructuring while preparing for an Article 9 sale
About Second Wind Consultants
Second Wind Consultants is America’s fastest-growing business consultancy, driven by a mission to preserve and generate economic value, with a core specialization in debt elimination that creates efficiencies for both owners and creditors. Second Wind works with private equity groups, alternative lenders, M&A professionals and trusted advisors across the country to facilitate new transactional solutions unavailable anywhere else.
For more information, contact:
Gary Nacht, Chairman and CEO
gnacht@synergyllc.net
(732) 406-0377