Sunday, June 19, 2022

A Reality Check to Better Understand Worst Case Scenarios for Owners


Worst Case Scenarios are Misunderstood

Those of us who make a living in the printing and graphic communication industry hardly need reminders of how hard it is for businesses to survive and grow. Even the owners, senior managers and investors in successful establishments recognize that fortunes can change for the worst case in an instant. 

The path from “healthy company” to “treading water” company can happen in a myriad of ways. It may start with a large customer downsizing its print marketing budget or with the departure of a key salesperson or with the news that a good customer has sold its business to a company that has its own supplier base to feed. The downward spiral can be set off by paper procurement challenges, as many companies struggle with this current dilemma [See, “Four Extreme Measures” below]. I sometimes remind myself that the owners of “treading water” companies who become my clients for non-bankruptcy debt restructuring or orderly wind-down of their business never thought they would ever need this kind of expertise. 

Perhaps you are reading this while enjoying success and just want to feel a little safer in pondering “what if” scenarios. Maybe your spouse is seeking reassurance about the future. Or maybe you and your partners are not on the same page about the direction forward and want to hear what is being said about others experiencing “worst case” outcomes. It could be that your company is seeking to grow by acquisition, and you are looking to learn valuable insights for connecting with owners of struggling companies. 

Whatever your reason for checking in, there is one—and only one—takeaway from this article: Worst case scenarios are misunderstood.

This is not a criticism of anyone. It is a statement about how hard it is to determine the path for graceful transition from ownership when it is out of necessity, such as when the sale of business or bankruptcy, are not attractive alternatives. This is similar to reading up on health issues that make the patient more informed to speak with a heart specialist. Do-it-yourself knowledge about bankruptcy, for example, may suffice to a point, but usually the “rubber-meets-the-road” issues are specific to the facts of the case. They require critical assessment by an industry-specific professional advisor who does this kind of work every single day.

FIVE COMMON OWNER MISUNDERSTANDINGS
IN CHALLENGING SITUATIONS

Statement: “I don’t have any personal guarantees to lenders, so I’m not worried if the business has to shut down.” 

Reality Check: Owners face threats of personal liability even if there are no personal guarantees. An owner is missing the “big picture” when believing that he/she can sleep at night because there are no loans or leases involving personal signatures. Sophisticated creditors can find “hooks” into the business owner based on actions or inactions that involve legal ramifications. One example is where the company took on new debt, such as paper bought on credit, where the business owner knew or should have known that the company will not be able to pay it back due to its worsening financial condition. Creditor settlements in non-bankruptcy cases almost always take into account this kind of personal liability risk; often unknown to the client. 

Advice: There is a series of similar “hooks” that only a seasoned professional can identify so that the merger and acquisition (M&A), and restructuring, can be planned with a view toward minimizing risk. Just saying, “I don’t have any personal guarantees so I’m not worried” is unwise. Personal guarantees expressed in contractual agreements with lenders was an issue in about half the non-bankruptcy orderly wind-down cases that I worked on in the past 6-12 months. Non-contractual personal liability was an issue in a third of the cases. Sometimes the personal liability stems from taking too much money out of the business in prior years, or it may arise from the timing and circumstances of purchasing paper and materials, or from inaccurate understanding of lease documents. The details on how assets are titled, the creditors that have filed liens, and who is responsible for liabilities, is based on careful review of documents. These are essential inputs in creating the “road map” for ceasing operations and the orderly wind-down of the company.

Statement: “My accountant says I have enough assets to get out from under the debt even if the company has to close down.” 

Reality Check: The accountant may be right about getting out from under debt, but industry-specific expertise is needed to assess several critical considerations before the client can safely rely on the accountant’s advice. In our “Second Opinion” evaluations, we find that there is a general lack of insight among professionals in understanding customer obligations such as deposits, postage, and work-in-process at the time of transition; the hidden costs of disposing of equipment including labor to run a press for showing it to equipment buyers; and the working capital necessary to implement the post-closing wind-down. This is all in consideration that there are expenses to be incurred beyond what is accrued on the balance sheet (one example: three to six months of infrastructure bills from the day of ceasing operations as a going concern to the final day in which assets are disposed).

Advice: The good news is that the value of intangibles are also misunderstood by many professionals who are not well versed in printing industry-specific M&A and restructuring. The value of customer relationships (the so-called “book of business”) does not appear on a balance sheet, leading to potentially devasting results. We had a client come to us, saying his accountant thinks he should just shut the business down now without any M&A. It turned out that the sale of intangible assets was in seven figures, making a huge difference in the ultimate outcome. It would have vaporized if the client did not seek a second opinion from a qualified expert in distressed company M&A.

Statement: “We can just shut down and take the customers over to another company where we’ll get equity.” 

Reality Check: The press operator would not even think about taking home the press, so why are some owners thinking that they can just take the customers with them when they leave the company? Except in cases with specific facts, customer relationships and data files/estimates/job tickets etc. are corporate intangible assets. It is a fallacy to believe that customers are NOT assets just because they are free to choose any supplier. Simply, a contract is not necessary to demonstrate that the customer relationship is an asset. This issue often comes up with salespeople, and it is the same point: customers are corporate assets. The owner may say: “But I started this business, all the customers know me. They will go with me to a new home.” Yes, but, depending on the facts, the value of customer relationship assets belongs to the corporate entity, not the owner directly.

Advice: If the company is insolvent, as determined by an industry-specific liquidation value analysis, then the creditors, not the owner, are entitled to the value of assets. The owner then could say, “no one will know” or “we can use some of that value to make settlements with creditors.” The latter has the hallmarks of a potentially good candidate for non-bankruptcy orderly wind-down of assets and liabilities. The former has the hallmarks of a potential litigation case for creditors to pursue against the individual personally, thus inadvertently creating a “backdoor” personal guarantee where there had been none.

Statement: “I’ve heard that the leasing company will just take back the equipment and we’d be done with them."

Reality Check: Although the occasional instance may arise where surrendering the equipment back to the lender is the final settlement. The underlying reality is that equipment lease obligations do not magically disappear simply because the equipment is given back to the lender. And “one size fits all” definitely is NOT the reality when it comes to guiding the client through the lease settlement process. Equipment lease negotiations are fertile ground for overstating what can or cannot be done.

Advice: A deep dive into the overall facts of the case is necessary. Solutions are not in the legal documents, but the legal documents must be reviewed carefully as part of the assessment of options.

Statement: “We’ll just close the doors and creditors will get nothing.” 

Reality Check: Owners who gloss over the complexity of financial restructuring on their way to “dreamland” may be surprised when creditors pursue aggressive legal action to collect from the company’s owners, officers, and directors even without personal guarantees. In fact, the more cavalier the owner’s attitude, the greater the likelihood of lawsuits involving breach of fiduciary duty, unjust enrichment, and fraud. By contrast, a comprehensive approach to treating creditors fairly is highly likely to succeed if the plan is designed and implemented by an industry expert.

Advice: Owners who want to treat creditors fairly, stand a much greater chance at an amicable parting of the ways with suppliers than owners who think they are entitled to take advantage of the situation as payback for years of paying supplier invoices.

This edition of The Hyde Opinion originally published by the Raymond J. Prince Graphic Communication Advisors Group

Tuesday, April 12, 2022

Paper Supply Constrains Industry



Recent feedback from owners of printing and graphic communications companies have led me to reflect on business viability implications of shortages in the paper marketplace.

Over the past several decades, printers have come to rely on and trust that a steady source of quality paper will be available on demand. This assumption has been changed, maybe forever, as a new reality confronts decision-makers across the spectrum of print-centric companies.

Paper supply has recently become a challenge regardless of a printing company’s annual revenues, or whether the company ownership consists of family members, business partners, or investors. “A refrain is now heard throughout the printing industry,” wrote Mark Hahn in The Target Report (See Printing Papers Get Squeezed Out – February 2022 M&A Activity), “paper supplies are very tight, allocations limit the ability to take on new customers, discounts and rebates are a thing of the past, shipments are delayed until price increases take effect, and printing and packaging companies increase paper inventories at every opportunity. The supply and demand curves have crossed, and the mills are in charge.”

According to Mark Hahn, my partner at Graphic Arts Advisors, “There are several reasons pricing leverage has shifted to the mills, including a labor strike at Finnish papermaker UPM, Covid-related supply chain disruptions, shortages of drivers, all in addition to the numerous closures of paper mills over the past several years.

“The paper industry has been chasing falling demand across the printing grades for a couple decades, closing mills, seeking to regain pricing leverage,” Mark wrote in The Target Report. “With the uptick in online purchasing and increased consumer spending across the board during the rebound from the Covid shutdowns, the stage was set for the significant shift in paper manufacturing now well underway. The result is that shuttered mills have reopened, and in the process, transitioned to packaging grades. Underperforming mills are purchased, and the new owners reconfigure the paper machines away from printing paper grades and to containerboard or kraft papers. Paper making operations are large and capital-intensive; the moves are major sea changes and will not be easily reversed. The result will be tight supplies of printing grade papers for the foreseeable future.”

Leading Companies Will Pull Ahead

One can view the current paper situation through the lens of long-term fundamental changes that have affected the printing industry, among others, the transition to electronic prepress, emergence of production-level digital printing, and migration toward internet-based job ordering. It is well documented that fundamental changes in the industry as well as economic events (such as the aftermath of 9/11 or the Great Recession) served to create distance between leading companies and those who are treading water. The gap widened considerably with the outbreak of Covid-19, as many companies struggled to survive. For some printing companies, Covid-19 created opportunities to take market share from those who could no longer compete. Factors that made a difference include the specific vertical markets a printing company served, retention of talented employees, and the strength of its balance sheet going into the crisis. The strong became stronger, the weak became weaker.

As the impact of the PPP loan and Employee Retention Credit programs fades, the gap between winners and losers is likely to be revealed. It stands to reason that the paper shortage will impact the weaker players more, at exactly the time when these companies need to reestablish viability without the largess of Federal government giveaways. Once again, the gap has widened between leading companies and those treading water.

The paper shortage is particularly troublesome because it impacts an entire organization, including salespersons, customer service reps, plant management, procurement professionals, production staff and ownership. Pressure is being applied to printing companies on both sides of the print production supply chain; customers seeking to confirm orders on one side and paper vendors juggling demand that exceeds availability on the other.

  Paper Availability - Warning Signs Flashing Red Alert
  1. Declining Profitable and Desirable Customer Orders Due to Lack of Paper
  2. Deadlines are Missed Because Paper Order is Late or Canceled
  3. Pressure on Profit Margins Due to Inability to Pass Along Paper Price Increases
  4. Customers Switch to Electronic Media Channels Due to Declined Print Orders
  5. Meeting Schedules with Multiple Makereadies but Customers Will Not Pay Extra

Turn a Negative into a Positive

As we speak with companies across the US, we hear that even strong companies are being tested to navigate the maze of options and solutions to procure adequate paper to meet customer requirements and deadlines. Within the broader set of problems, there are also opportunities.

We know of one client in California who tweaked their inventory reporting system by adding a visual display to paper pallets in the warehouse. The signage, with the date of purchase and the cost of paper, matched the paper to specific customers for jobs scheduled months in advance, a cash-draining change for a company that was accustomed to real-time paper procurement. The new signage was a component of an awareness campaign to optimize working capital management in other areas to offset the cash now tied up in paper inventory. The result was improvements in press productivity, waste reduction, and in the front office, faster AR collection. In essence, the paper shortage became a rallying point for the troops who responded favorably.

Another client, a successful family-owned printing company in the Carolinas, noted that they successfully increased their internal manufacturing hourly rates in addition to obtaining an increase to cover paper costs. The general awareness of inflation, coupled with publicly announced paper price increases, created the opportunity to address the previously uncomfortable topic of price increases. As print customers learn that their print suppliers will gladly use their paper allocation to serve other customers, resistance to price increases has softened. Print buyers that go price shopping find that print suppliers cannot, or will not, allocate limited paper availability to bottom-fishing buyers. This has created the opportunity for across-the-board price increases, including internal rates attributed to labor and production costs.
   
  Paper Availability Affecting Business Viability - What to Do
  1. Arrange for Rapid Financing from Family & Friends Supported by Private Lender Legal Structure
  2. Form a Strategic Alliance & Outsource to Compatible, but Stronger, Business Partner
  3. Implement a Lightning Quick Sale of Challenged Business to Preserve Remaining Value
  4. Plan for Graceful Transition from Ownership Before a Sudden Shut Down is Unavoidable
  5. Avoid the Expense & Reputational Harm of Bankruptcy & Plan for Orderly Wind-Down

A client in the Midwest has augmented their M&A outreach program with offers of management, financial, and production outsourcing support to prospective acquisition targets that they know are struggling to obtain paper. This communications messaging is essentially the 2022 version of the time-tested strategy of enticing struggling target companies with much needed relief as inducement to respond to the buyer’s solicitation of interest in M&A.

Contact John Hyde, Esq. for a confidential discussion of any of these or other options (john@graphicartsadvisors.com; 646-220-4431).

Saturday, November 20, 2021

Graceful Transition from Business Ownership When Traditional Options Are Not Attractive


The respected owner of a Bridgeport, Connecticut, manufacturing business sat back in his office chair. He was finally relaxing after a day in which he and the young man who was his restructuring advisor fielded calls from angry unpaid suppliers. The strain of financial challenges facing his high-profile company had been emotionally draining on the owner and his family. He was worn out from the grind, and in his late 60s he was no longer the resilient entrepreneur who built the business from the ground up. The tone was somber, the owner became reflective: “For years now, people have knocked on the door here, asking for advice on how to get in business,” he said, looking up from a notepad, “but no one ever comes here to ask how to get out of business.”

The relevance of that conversation has endured the passage of time, and it finds new meaning in the current environment facing business owners in the printing and graphic communication industry. 
As Covid-relief funds begin to dry up, many owners are once again asking: “Is it worth going forward or is this the time to get out of business?”

The potential of a lucrative M&A sale of business is achievable for some, but not all privately held establishments that dot the landscape of the printing, graphics, packaging, finishing, mailing, and related industries. This pathway for maximizing business value may go through private equity buyers or strategic acquirers, and is well documented in The Target Report, published by my colleague, Mark Hahn of Graphic Arts Advisors, LLC. For others within our industry that do not fit the criteria for a “healthy company M&A transaction,” the options are narrower but the overall need for business transition solutions is far greater, considering the constant struggle to survive that has taken a toll on countless owners.

Owners of companies who had been treading water prior to Covid-19 may turn to unconventional options for business transition. “I never thought I’d be in a position like this,” said the third-generation owner of a printing company while preparing for an upcoming equipment auction; his company already having ceased operations without any M&A transaction. “I always thought I’d ride this thing out and eventually get the prize of a buyer paying me real money for the business. I worked so hard to make this company successful, but I don’t have the same energy at 60 as I did at 40. The time has come to move on.”
   
  Common Forms of Business Transition in the Printing and Graphic Communication Industry
  1. M&A Sale of Business as Going Concern to Strategic Acquirer
  2. M&A Sale of Intangibles and/or Equipment, followed by Orderly Wind-down of Corporate Entity
  3. Transfer of Ownership Interest to Next Generation by Succession Sale of Business 
  4. Orderly Wind-down of Assets and Liabilities (with or without monetizing intangibles value)
  5. Divest Printing Industry-related Assets and Convert to Real Estate Holding Company

For those owners who have struggled in recent years, here are five questions for consideration in thinking about business transition:

Question 1: What is the time frame based on the life cycle stage and relative health of the business?

Caution: Companies who have been treading water sometimes deteriorate at a more rapid pace than the owner had expected as the end approaches, causing turmoil and pressure to “get out from under” while there’s still something to preserve.

Advice: One tool to assess survivability is to track the ratio of cash receipts to new billings. This means if the business is taking in more cash than it is replacing with new receivables, the liquidation has essentially started before the owner realizes it.

Question 2: Who is making the decision on “whether”, “when” and “how” to get out of business?

Caution: If the company is not paying its bills on time or has more debt than assets, then these critical decisions really belong to the company’s creditors, not the shareholders or partners or members. The concept of maximizing value for creditors comes from the arcane world of bankruptcy and non-bankruptcy debt restructuring, but there does not have to be a bankruptcy case for the legal construct to be applicable.

Advice: If the company is behind in its bills, check whether the company is paying out more in “good faith payments” or partial payments on account or other debt reduction than it is making in profit from new jobs going out the door. If so, the decision on getting out of business has already been made.

Question 3: Where do you stand on the ethical issue of doing right by your customers and employees?

Caution: Beware of unexpected costs of winding down the business such as final employee obligations and customer liabilities. Remember the snowy evening where the night shift operator came to the company despite the blizzard, just so a big job could get out the next morning? You may not, but he/she probably does and will likely remind you about it on the way out the door if the business transition is not implemented with care and compassion. Accounting and planning for wind-down are not the same thing.

Advice: Develop a list of orderly wind-down expenses that go beyond the usual accruals that show up on the company’s balance sheet.

Question 4: Who legally owns the assets and liabilities of the “treading water” company?

Caution: The details on how assets are titled and who is responsible for liabilities is based on careful review of documents are essential inputs in creating the road map for going out of business.

Advice: The press operator would not even think about taking home the press, so why are salespersons and some owners thinking that they can just take the customers with them when they leave the company? Except in cases with specific facts, customer relationships and data files/estimates/job tickets etc. are corporate intangible assets and belong to the equity holder and/or the creditors.

Question 5: Why is non-bankruptcy orderly wind-down usually more attractive than bankruptcy?

Caution: The primary reason why very few companies in the printing and graphic communication industry file for bankruptcy is that the process negatively affects customer relationships. Rather than preserving business value, bankruptcy itself diminishes the value of the intangible assets.

Advice: Bankruptcy is the legal backdrop against which restructuring and non-bankruptcy cases are designed; however, the filing of bankruptcy would require all creditors in certain buckets to be treated equally. In non-bankruptcy, creditors must be treated fairly but not equally. That is a huge difference in making the non-bankruptcy orderly wind-down process more palatable to owners who want to achieve a graceful transition. There is a built-in way to be sure that the local die cutter or free-lance designer is taken care of. That does not mean the owner can arbitrarily pick favorites or pay their friends at the expense of other creditors. There must be a business purpose to the architecture of the plan, rather than random one-off payments.


An earlier version of this article were first published by the Graphic Communications Advisors Group.

Friday, June 4, 2021

Five M&A Takeaways from the Pandemic Front Lines


The one-year anniversary of the outbreak of Covid-19 has passed and the much-anticipated tidal wave of failed businesses never happened. The expected deluge of cash-strapped owners seeking immediate relief in the form of distressed company M&A did not materialize. Rather, the marketplace has been defined by owners accelerating plans for an orderly transition from ownership (sellers) and more aggressive, but reasonable, pursuit of M&A by healthy companies seeking new growth opportunities to make up for lost revenues (buyers). With the backdrop of a debtor-friendly creditor climate and strong cash positions on many balance sheets, the environment is ripe for active deal-making in all sectors of the printing, packaging, graphics, and mailing industries.

Here are five takeaways from the frontlines of M&A in our industry:

PPP loans have extended the life of companies that were already treading water

There is little doubt that the massive influx of money from the United States Small Business Administration (“SBA”) under the Paycheck Protection Program (“PPP”) extended the lifespan of many companies that otherwise would have shut the doors. One can debate the political, social, and economic issues related to the PPP initiative, but without dispute is the practical reality that the PPP money was a welcome shot in the arm for shoring up P&L deficits over the past 15 months. Skeptics would argue the money simply deferred the inevitable demise of treading-water companies, but only time will answer the question more fully.

The single most frequent issue surrounding M&A over the past year has been how to advise clients on PPP debt implications

Many professionals would say that the simplest answer is to treat the PPP debt as just another loan on the balance sheet of the seller. In traditional M&A where the seller, at the time of closing, has sufficient assets to fully satisfy all liabilities, the PPP loans become a topic for planning among the accountants and lawyers. But in the context of unwinding the balance sheet of an acquired company that has more debt than asset values, professional advice surrounding the PPP funds has tended to be especially cloudy, leaving principals with uncomfortable uncertainty.

PPP Loans add complexity to the art and science of structuring non-traditional M&A transactions

The range of PPP loan issues that land on the desk of a restructuring expert includes:

ü  the likelihood of formal SBA forgiveness of PPP debt based on the moving target of guidelines and regulations;

ü  the relative priority status of UCC-1 security interests filed by the bank issuing the PPP loan;

ü  misreading of the implications of “no personal guarantee” that had been eye-catching on the front-end borrowing;

ü  the role and competence of the issuing bank which introduces another variable to the situation;

ü  the timing of M&A transaction closing and formal SBA forgiveness approval; and

ü  the requirement imposed by SBA regulations to escrow funds at the time of M&A transaction closing.

Banks have not lit the proverbial match (yet?)

The Covid-19 climate has not negatively affected the delicate relationship between banks and commercial borrowers. This could change in the months ahead, especially as PPP funds run dry, however in our industry we have not seen a surge in demand letters, requirements to provide 13-week cash budgets, collateral audits, onerous renewal terms, forbearance agreements, or other hallmarks of conflict between banks and business owners. Any change in the banking climate could easily have a cascading effect, given the number of companies that are skating on thin ice due to Covid-19 revenue gaps. Interestingly, the creditor group that has had the biggest impact on Covid-19 has not been the banks, but the leasing companies. In our experience, leasing company creditors got the ball rolling in a favorable way when the pandemic broke out in early 2020. The general willingness to defer payments on equipment debt gave owners a financial cushion as well as a much-needed emotional boost at exactly the right time.

Lower creditor settlements have helped offset the decline in M&A value

Numerous experts have weighed in on the impact of Covid-19 on business valuations; however, very few commentators have explored the relationship between M&A value and creditor settlements in the Covid-19 era, especially in the printing, packaging, graphics, and mailing industries. Distressed companies are faring better in workout negotiations than at any time in recent memory. This is partially due to the sheer volume of problem debts that have exposed shortcomings at institutions who lack seasoned personnel to work on restructuring cases that require focus, expertise, and rapid decision-making. Another factor has been the recognition that the pandemic was beyond the control of the debtor with a resultant more empathic creditor response. The net effect is that overall creditor settlements are lower than they were in 2019 or 2018. During the past 15 months, creditor’s understanding and flexibility has helped some distressed company owners to offset the decline in M&A value.

Sunday, January 17, 2021

Are Losses Draining Your Energy and Finances?



Muddy Waters
  • Cash is always tight, scrambling to meet payroll and pay suppliers.
  • Hard work does not seem to be helping; you’re going nowhere fast.
  • Relationships with close family, favorite trade suppliers, and good employees are strained and near the breaking point.
  • Company resources are going down the drain and there is no way to plug the flow.
  • Every effort to plug the continued losses has failed and it is time to face the reality that your company may not be able to stay in business.
The finality of it all stands in stark contrast to the “better days ahead” optimism that was the coping mechanism for yesterday’s challenges. Realizing that the dream of continuing to operate as an independent company is rapidly slipping away, thoughts turn to shutting the doors, filing for bankruptcy, or selling everything to get out from under.

Time is Not Your Friend; Act Sooner Than Later

It is counter-intuitive, but the great majority of owners who eventually get through the painful process of winding up their company come out the other side healthier, happier, and with renewed vigor. For these individuals, the transition from business ownership while under duress serves as a life changing experience. Frequent remarks are:
  • “I should have done this sooner.”
  • “I didn’t realize what it would be like to get my life back.”
  • “I was sadly misinformed, not realizing that there were more graceful alternatives than filing bankruptcy or walking away.”
No one ever chooses to be in this situation; regardless of whether the underlying cause of business demise was Covid-19, the credit crunch of the Great Recession or the tragedy of the 911 attacks. The universal truth from many cases is that there can be light at the end of the tunnel, and that light is not an oncoming train!

The starting point out from the tunnel of darkness has nothing to do with financial statements or traditional advice from accountants or lawyers. It has to do with self-assessment of your emotional mind-set.

Do any of the following four comments resonate with you?
  • “I am done. It is time to get out from under and do what is right for me. I want to take care of my employees and customers. I want creditors to be treated fairly. But it’s time to move on.”
  • “I have no time for thoughtful planning; I am too busy chasing money and keeping the wolves at bay.”
  • “My lawyer and accountant tell me I am nuts to keep throwing money at it, but I’m not 100% convinced.”
  • “I am not giving up, if there is a way to preserve what I have, I will find it. But if it is not realistic, I can be at peace knowing I did everything I could, and I transitioned from ownership in an ethical, legal, and compassionate way.”
When an owner acknowledges to himself/herself that staying in business is no longer an option, there is often a sense of relief in knowing that the focus has shifted from “whether to stay in business” to “what are my options, when do I make the move, and how do I go about this?”

The Survival Clock is Ticking

Once an owner acknowledges the inevitable, “what are my options” should not be the very next question. Think of this as an emergency room scenario. The patient checks in and is in distress. If the distress is acute and death is imminent, extreme immediate measures may be warranted. It’s open heart surgery time. Long term options such as a change of diet and an exercise regimen won’t solve the problem. It may be too late for planned elective surgery as a safer alternative. Time remaining on the proverbial clock defines the universe of options. Does the patient have years? months? weeks? days? hours? I call this the “survival clock” – this drives the subsequent decisions.

The most common answer is “a few months” and, using the medical metaphor, the owner can plan elective surgery to save significant elements of value with a softer landing for shareholders, employees, creditors, and customers. Indicative conditions would include:
  • Available credit is maxed out and/or the company’s lender has cut the line of credit to avoid more exposure.
  • Accounts receivable collections exceed new billings to customers over an extended time period.
  • Suppliers are tightening up their credit terms.
  • The company keeps losing more customers than it gains new customers.
  • Good employees are leaving or planning to depart.
If more than three of the following six warning signs of extreme danger are present, the survival clock is probably measured in a few weeks, maybe a month or two (but not many months), and rapid progress is advised to avoid a total loss of value and a hard landing for constituents:
  1. Bounced checks are becoming normal.
  2. The company is unable to pay complete payroll and is only funding net payroll, deferring IRS payroll taxes and other trust deductions in an effort to preserve cash.
  3. Utility bills are not paid in full each month and there is an expanding accrual of 30 days or longer on electric, gas, phone, and internet.
  4. Premature invoices are issued to create receivables for presentation purposes to lender or other stakeholders.
  5. Financial problems are regularly affecting customers and key employees; they are losing patience.
  6. Critical suppliers of paper, ink, toner, and maintenance have cut off new orders or have imposed onerous requirements to continue conducting business with the company.
Time to Pull the Plug?

A word of caution about owners doing their own self-assessment of time frame. Owners often misread how much time is left on the survival clock. Just like water going down the drain, the rate of business deterioration goes faster near the end. It appears slow at first, almost imperceptible. Let some time elapse and what happens? At some point, the losses are clearly visible, the water is circling. Finally, the last bit of water disappears in an accelerating spin that cannot be stopped.

Wednesday, April 22, 2020

PPP and the Law of Unintended Consequences


SBA Paycheck Protection Program (“PPP”) Loans carry strings attached that should not be ignored. Although there is little doubt that this funding program can be an enterprise-saving measure for seriously cash strapped businesses, owners of printing, packaging, and graphic communications companies who are treading water financially should consider implications for M&A and debt restructuring that extend beyond the immediate cash relief. Here are two examples:

The Remaining Balance of the PPP Loan is Due in Full Upon a Change in Ownership

The PPP Loans have an impact on the balance sheet regardless of whether they can be forgiven or not. The default provisions of the Promissory Note used by the SBA (and adopted by issuing banks) capture a wide range of shareholder actions. They read in relevant part: “Reorganizes, merges, consolidates, or otherwise changes ownership or business structure without Lender’s prior written consent.” Interestingly, the default provisions fail to expressly include the “sale of all or substantially all of the assets.” Nonetheless, the words and meaning strongly reflect an intention to apply the provisions broadly. Owners ignoring this clause by relying on legal hair-splitting are taking a big risk. The borrower may wish to believe the risk can be lowered by seeking the Lender’s prior written consent. In theory, this makes sense, in practice this should not be viewed as an iron-clad solution. It remains to be seen how the banks, who are charged with the monumental task of administering the PPP Loans, will carry out this procedure. Historical precedent is not favorable, given that the SBA, in my nearly 30 years as a consultant and attorney, has earned a poor reputation for responding to requests from business borrowers. Modifications, forbearance agreements, settlement offers, restructuring proposals, etc. are frequently delayed due to red-tape, a walked-to-slow-death, or outright rejected even where they make sense.

The PPP Loans are General Unsecured Obligations

For companies considering bankruptcy or shutting the doors, it would be a serious miscalculation to regard the PPP Loan as corporate welfare that is easily walked away from. The debt is not going to magically disappear simply because the company tried but failed to survive. It was the public sector that effectively lent the money, but it appears, in my opinion, that it will be the private sector, not the government, that collects the debt. In all likelihood, it probably won’t even be the banks that will ultimately end up acting as debt collectors for unpaid PPP Loans. This is exactly what happened in the 1990’s when large private pools of capital purchased defaulted loans from the banks. The lawsuits, workout negotiations, settlement proposals, and the related administration were handled by investors who profited from buying the defaulted loan at bargain prices and converted the debt into cash from settlements, judgements, etc. It’s worth pointing out that the standard form of SBA Promissory Note contains much of the legal ammunition favored by bank’s special assets departments and similar collection organizations. And the document itself clearly states the phrase “Lender includes its successors and assigns.” It is likely to be left to the private investor-speculators to consider and use hard-ball tactics involving “accidental personal guarantee” and potential personal liability for owners and officers of companies who borrowed but did not pay back the PPP loans (see, The Hyde Opinion, Beware the Accidental Personal Guarantee).

Friday, April 10, 2020

Beware the Accidental Personal Guarantee


The SBA Paycheck Protection Program (“PPP”) is today’s rage among business owners fighting for survival in the Covid-19 environment. While the overall features and benefits of the program are excellent, a common misperception is making the rounds: business owners are not personally responsible for the SBA PPP debt.

As an advisor to financially challenged companies, I fully appreciate the popular appeal of this catch phrase. The danger, however, is that owners hear these words and fail to fully understand the broader context and the risks that could result in being on the hook to the federal government. While the legal documents are clear about “no personal guarantee,” they contain other provisions which could serve as a backdoor to personal liability.

Among possible triggers that could create an “accidental personal guarantee” and potential personal liability for the PPP debt:

Unauthorized Use of Funds: The guidelines published by the US Treasury include the statement, “If you knowingly use the funds for unauthorized purposes, you will be subject to additional liability, such as charges for fraud.” They continue: “If one of your shareholders, members, or partners uses PPP funds for unauthorized purposes, SBA will have recourse against the shareholder, member, or partner for the unauthorized use.” Unauthorized purposes are broadly characterized as any expenses other than what is permitted such as payroll, rent, utilities, and certain interest.

Business Determination of Necessity: The application for the PPP funds require the borrower to certify that “current economic uncertainty makes the loan request necessary to support the ongoing operation of the applicant” (italics added). While there is a big gray zone on whether the funds are “necessary,” the question of necessity paves the way for personal liability for those borrowers that flagrantly violate the spirit of the program.

Individual Certification Requirement: The US Treasury has set up the SBA to play hardball down the road by requiring the person signing the application to certify that it is true and accurate in all material respects, stating that “I understand that knowingly making a false statement to obtain a guaranteed loan from SBA is punishable under the law.” The guidelines require applicant’s signoff on understanding that the bank can share tax information with the SBA Office of Inspector General for the purpose of compliance with the SBA Loan Program Requirements. These provisions give the SBA flexibility and authority to pursue personal liability cases without actual personal guarantees.

Business owners of companies that were financially “treading water” before the outbreak of Covid-19 should understand that there does not have to be a signed personal guarantee to become personally liable for a debt. There are often additional landmines where a misstep can result in accidental personal liability.