While the potential impact of COVID-19 on supply chains and the global economy has been widely reported, the severity of the impact on companies’ operations remains unknown. These factors may place downward pressure on many businesses’ revenues and cash flows – and ultimately on their capital structures – especially those that are highly leveraged. Companies confronted with these challenges often evaluate three strategic alternatives: balance sheet restructuring, sourcing additional capital or pursuing a sale transaction.
Balance Sheet Restructuring
An impending or actual breach of a financial covenant in a borrower’s credit facility is an early warning sign of financial distress.
- Lenders are:
- Closely monitoring the performance of their borrowers and carefully evaluating any covenant defaults.
- Assessing the preparedness of borrowers to deal with any defaults, as well as what corrective actions borrowers might take.
- What you can do to restructure your balance sheet?
- Communicating frequently and transparently with lenders can go a long way to ease concerns and set the stage for a successful balance sheet restructuring – whether a resetting of financial covenants or realignment of outstanding debt to better fit the current state of operations.
- Communicating frequently and transparently with lenders can go a long way to ease concerns and set the stage for a successful balance sheet restructuring – whether a resetting of financial covenants or realignment of outstanding debt to better fit the current state of operations.
Alternative Capital Sourcing
Traditional funding sources are not always available in a disruptive market, and new funding is often needed to address
- Today, debt capital markets remain open, but this could potentially change if market conditions worsen and debt defaults begin to ramp up across the business landscape.
- What can you do if the debt markets tighten or close altogether?
- Turn to alternative sources of debt capital, typically non-bank lenders, that are well suited to quickly analyze and fund companies in financial distress. While they maybe more expensive than “traditional lenders”, alternative capital sources typically provide more favorable lending terms and greater covenant flexibility, allowing businesses to navigate choppy markets.
M&A Considerations
If the level of financial distress or required capital investment is more significant, an M&A transaction may be the optimal path to pursue.
- In a disruptive market, the greatest challenge to an M&A process may be the typical timeline, which can stretch from 6 – 9 months. An accelerated M&A process is frequently required in distressed situations, which can significantly shorten the timeline to as little as 1 – 3 months.
- What does an accelerated M&A process look like for your business?
- An accelerated M&A process typically includes “special situation” investors, comprised of financial sponsors who are well-equipped to react quickly, perform diligence, and close transactions on an expedited basis.
- If the potential transaction is complicated by debt defaults and the distracting influence of recalcitrant creditors, companies can avail themselves of the protections offered under Chapter 11 of the US bankruptcy code which stays creditor actions while a sale transaction or debt restructuring is concluded.
The M&A process may need to be accelerated as a result of financial distress
Solvent
Financial Condition Continuum
Insolvent
Traditional process: 6 – 9 months
Going concern
- Profitable
- No cash flow or working capital concerns
- Standard warranties and indemnities
- Negotiations between buyer and seller only
- Valuation mutually agreed upon by parties
Under pressure
- Growing cash flow and operating performance concerns
- Going concern value in question
- Approaching “zone of insolvency”
- Limited access to capital
- Requires operational and/or balance sheet restructuring to avoid bankruptcy
Accelerated process: 1–6 months
Business in bankruptcy
- Chapter 11 filing required to stay creditor actions
- Covenants breached and DIP financing typically required
- Multiple constituents involved in process and decision making
- Public auction process of assets to repay creditors
- Sale is free and clear, final, and requires court order to confirm
KPMG Corporate Finance LLC can help you evaluate and address the following capital structure issues within a disruptive market environment
Covenant analysis Developing a financial model to stress-test financial covenants and analyze headroom under different operating and cash flow scenarios is important to assess the likelihood of a potential loan default.
Lender communications Transparent communications with lenders regarding the business outlook, challenges encountered, and planned corrective actions will enhance credibility and drive success in any restructuring dialogue.
Creditor negotiations Resetting covenants, addressing maturity dates, and potentially right-sizing the capital structure to better fit the long-term operational outlook are potential topics for discussion with creditor constituencies
Alternative capital sourcing Refinancing existing lenders or sourcing additional junior capital may be needed. It’s important to have multiple parties at the table including non-bank lenders, credit funds, and other alternative capital providers.
Business plan modeling Preparing a forecasting model that will facilitate efficient due diligence and funding is critical. Investors will require an updated financial forecast to most effectively structure any new capital investment.
Lender due diligence Lender diligence can be taxing on already strained management resources, especially when multiple capital providers are involved. A third party advisor can be helpful in coordinating and expediting the due diligence and closing process.
Accelerated M&A process An efficient and expeditious M&A transaction involves the following key steps: developing the transaction strategy, preparation of marketing materials, negotiating with buyers, and closing.
Special situation investors Involving investors from the “special situations” community in your M&A process can expand the number of potential buyers while simultaneously allowing for accelerated diligence, negotiations, and closing.
Chapter 11 strategies If the situation becomes highly stressed, consummating a sale through Chapter 11 could provide additional time to forestall creditor actions, such as foreclosure processes, and preserve value for your business.
