SCG_ib_mab_distressed

What Is Distressed M&A?
The investment banking discipline known as Distressed M&A is a relatively new one,
having been formalized during the mid- and late-1980’s at Goldman, Sachs by members
of its M&A Department and Restructuring Group, where Spectrum’s Mike Lederman
served as one of two Vice Presidents. The immediate impetus for the development of the
Distressed M&A discipline was the relatively sudden way that many of that decade’s
pioneering LBO transactions found themselves flying off-track.

If nothing else, these faltering transactions shared two features above and beyond the
ubiquity of too much debt and no access to the capital markets for liquidity: first, declining
operating performance and cash flows that practically guaranteed enterprise valuations
below those of the original LBO transaction, and secondly, liquidation values that were
materially below going concern values. In other words, although these M&A candidates
did not have a future as independent operating entities, what they did have was some
combination of technology, skilled employees, real estate, customers, distribution, or
other features that were worth more to the company’s stakeholders if disposed of
together as a going concern rather than in a liquidation.

Hence, the essential challenge of Distressed M&A is maximizing value in a context that
frequently includes widespread knowledge that the target has no alternative to selling,
the inherent disruption of an imminent Chapter 11 filing or one that has recently occurred,
low employee morale and high management turnover, and significant liquidity (and
therefore time) constraints. On top of all this, the Distressed M&A investment banker may
also have to deal with attempts by the target’s out-of-the-money stakeholders to improve
their position by threatening to, or actually, disrupting or delaying the sales process,
thereby holding hostage the likely recoveries of the target’s other stakeholders.

The Role of the Distressed M&A Investment Banker
Distressed M&A transactions sometimes have little in common with traditional, friendly
M&A deals. The investment banker conducting a Distressed M&A transaction often
requires all of the skills of a traditional M&A banker plus a number of other attributes.
First and foremost, the Distressed M&A investment banker must be intimately familiar
with the requirements of Chapter 11, particularly the provisions of the Bankruptcy Code
concerning the sale of the debtor’s assets outside of a Plan of Reorganization.

In designing a process for conducting a Distressed M&A sales process, the investment
banker must be able to use the Bankruptcy Code to create value and allay the concerns
of prospective purchasers and the target’s creditors that arise with regard to issues such
as:

		Positioning the business, the process and deal structure to maximize value
		Valuation (the art of valuation requires in this context that the experienced
		investment banker apply a number of subjective analytic modifications to traditional healthy company valuations)
		Environmental matters
		The use of a “stalking horse bidder”, and the break-up fees and overbid
		protections that are appropriate to a given situation
		Fraudulent conveyance exposure
		Exposure of members of the debtor’s Board of Directors
		The rejection of leases and executory contracts; and
		Taxation (cancellation of indebtedness income; net operating loss carryforwards)
		Title (transferring property free and clear of existing liens)
		The requirements of a Plan of Reorganization with regard to issue such as
		feasibility and cram-down.

The Distressed M&A banker must also have the experience to make decisions and act
upon them quickly before the target company runs out of cash, leaving a messy
liquidation as the sole alternative. This requires the banker to continually assess trade-
offs between time and value throughout the sales process.

Executing a Distressed M&A transaction is often difficult. Putting aside the problems
inherent in attracting prospective purchasers to a highly regulated auction process with
tight time frames and sometimes unsatisfactory due diligence, getting the transaction off
the ground can be a challenge principally because the proceeds of the deal are unlikely
to satisfy all of the claims on and interests in the company, a sure-fire formula for a
contentious zero-sum negotiating dynamic.

Success requires that the target’s investment banker and other professionals possess
credibility with the company’s creditors and the negotiating ability to convince multiple
parties to support the M&A process advocated by the target. A distressed company’s
secured creditors, unsecured creditors’ committee, landlords, regulators, taxing
authorities, shareholders, directors, and management team may have conflicting and
shifting positions with regard to a host of issues, and the Distressed M&A investment
banker must have the savvy to get the parties to put these differences aside in favor of
executing a sales process designed to maximize value, even if this means putting off to
the future existing disagreements over which parties should get how much of the
proceeds. To do this, the banker must also be able to communicate effectively with, and
leverage off of, the other specialized principals and professionals involved in distressed
transactions, including crisis managers, bankruptcy lawyers, bank workout groups, other
investment bankers, bond holders, and distressed investors.






					© Spectrum Capital Group, LLC. 2005. All Rights Reserved.