Troubled companies and their advisors are increasingly finding value in pursuing substantive balance sheet restructurings out of bankruptcy court. This shift has been driven by a number of factors, including the availability of risk capital, pressure from creditors to minimize costs, reduced management control in the context of bankruptcy, and the ability to negotiate favorable terms with severely impaired creditor constituencies.
As more companies facing financial distress seek to reorganize out of bankruptcy court, the key driver in right-sizing a balance sheet has shifted from aggressive legal tactics to savvy negotiating. Increasingly, advisors to distressed companies must be prepared to drive substantial, and potentially life-saving, change in their clients through impactful negotiations with key stakeholders.
Understanding the Situation
Companies in distress often find themselves “stretching the trade”, or delaying payment to their vendors, as they struggle with declining cash flow. As a result, by the time a restructuring plan is developed and implemented, vendors are often considerably outside of their agreed upon terms. It is not uncommon to see distressed companies with overall days payable outstanding (DPO) above 60 days, and for some key vendors to be well above 90 days.
Too often incumbent management sees this vendor stretch in overly simplistic terms, i.e. as a necessary evil. This viewpoint is not only unhelpful but is actively counter-productive. The first step in laying the groundwork for a successful renegotiation of trade payables is to understand the current state of affairs from the standpoint of the vendors. For a $100 million company with 40% gross margins, an increase in DPO from 30.0 to 75.0, which would not be an uncommon, would drive an increase in Accounts Payable from $5.0 million to $12.5 million (see Exhibit A).
- Exhibit A: Accounts Payable as a Function of DPO
Companies in distress often fail to appreciate the wrenching change that this level of vendor stretch can have on an organization. If left unchecked, vendors in this situation will demand prepayment on all shipments, initiate legal action, and ultimately cease to provide goods and services.
Crafting a Solution
Managing the successful restructuring of trade payables is a process, with multiple discreet but inter-connected steps:
• Develop a Comprehensive Restructuring Plan. Trade payables cannot be restructured outside of the context of a comprehensive restructuring plan; to do so would be to risk a further erosion of goodwill among key vendors, and threatens to waste valuable time and resources. With a comprehensive restructuring plan in place, it should be possible to determine the level of concessions necessary from vendors, and the point at which bankruptcy becomes a viable option.
• Classify Vendors. Vendors should be put into categories based on their relative level of importance, with each category having a targeted rate of recovery. Mission-critical vendors would receive the highest recoveries, with vendors providing easily resourced items receiving the lowest. By adding this level of granularity to the process, an achievable, bottoms-up calculation of trade payables forgiveness can be targeted (see Exhibit B).
- Exhibit B: Trade Payables Forgiveness
• Draft a Settlement Agreement Template. Legal counsel should be retained to provide support in the drafting of a settlement agreement template that is sufficiently versatile to serve the needs of most individual vendor negotiations. Some adjustments are to be expected on a case-by-case basis, but the expectation should be that most vendor claims can be settled using the settlement agreement template, thereby minimizing the need for counsel to be involved in each individual vendor negotiation.
• Vendor Negotiations.
o Initiation: Negotiations should be initiated via a form letter to all vendors, outlining the current situation, the goal of the out-of-court restructuring, and the process for the settlement of trade payables. It is often helpful to create a financial packet illustrating the company’s need to restructure claims.
o Tracking: The process of negotiating multiple settlements and maintaining contact with vendors for whom negotiations are ongoing is a time-consuming one. Proper tracking should be developed to keep the management and advisory team apprised of all developments.
o Bankruptcy Considerations: In the course of negotiations, bankruptcy should always be a reference point. As a result, it will be important to maintain visibility on prospective 503(b)(9) claims as well as allowable landlord claims, as these are afforded a higher level of priority in a bankruptcy filing.
A substantial restructuring of trade payables is achievable outside of the context of a bankruptcy filing, but only if a distressed company, supplemented by a talented advisory team, is willing and able to commit itself to a robust process. Companies do not find themselves with dangerously strained vendors overnight, and the solution, whether in or out-of-court, is likewise not immediate. The key to success in this arena, as with so many aspects of restructuring, is the versatile management of the nexus of strategy (the restructuring plan) and tactics (the action steps). Successful management of that nexus invariably yields impressive client outcomes.