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).