The primary reason Section 363 sales are popular is because there are distinct business advantages for all constituencies – investors, debtors, debtors-in-possession, creditors, trade vendors, and professionals.  The advantages to investors (buyers) are clear:  The assets are conveyed free and clear of liens and encumbrances, relieving fears of lingering liabilities and causes of action, etc.  By investing in this way, they can, in rudimentary terms, keep the good stuff and get rid of the bad stuff.  Furthermore, investors rest easy knowing, at the close of a competition, they paid no more than the fair market price for the assets, a certainty they do not have if they negotiate with a creditor rather than participate in a process.  

      Advantages to owners and management are not as well appreciated, but they are substantial, and savvy business people seize the opportunities afforded by 363 sales.   Owners can compete for the assets and enjoy all the advantages of the process afforded to any other investor – keeping the good stuff, getting rid of the bad stuff.  If they have resources of their own, or can attract partners, they are well positioned.  If they do not have access to money (which is often the case with smaller companies because they have already poured everything into the business), the process itself gives them tremendous opportunity to persuade investors attracted by the sales and marketing process to put them on the team.  Who better knows the potential of the assets, or perhaps more importantly, what not to do going forward?  Additionally, secured creditors often look more kindly on owners who maximize value when it comes to discussing personal guarantees. 

      The advantage of supporting a 363 sale process to the Debtor In Possession (DIP) is crystal clear:  fulfillment of its fiduciary responsibility to maximize the value of the assets and recovery to creditors.  Employing true professionals to conduct a robust, exhaustive and effective sales and marketing campaign to attract new investors is a far better way of maximizing value than poorly capitalized plans of reorganization that are highly likely to join the rank of “Chapter 22s.”

      Because investors enjoy so many advantages, they will bid aggressively if a strong sales and marketing campaign has been properly executed.  Obviously, aggressive bidding benefits creditors because it maximizes recovery.  In 363s creditors also have the backstop afforded by credit bidding, eliminating the risk of taking a hair cut that is simply too severe.  Finally, a recapitalized company that has shed the bad stuff may well be a good credit in the future, creating an avenue to get money out profitably.

      Trade creditors garner similar advantages.  Recovery is maximized and a new, more credit-worthy, customer is created.  While they would prefer to have had their bills paid in full as in a normal course of business, this is often making the best of a bad situation.

      Finally, 363 sales solve a vexing question for professionals:  How do you provide the level of service and expertise clients deserve and require when the source of funding is by definition on shaky ground?  A financial transaction that maximizes value resolves the issue by creating a pool of cash to pay administrative claims.

      Taken together, these advantages explain why sales are so prevalent.  Simply put, the business reasons are so sound and compelling in many circumstances that the technique is rightly popular.  All constituencies benefit and recapitalized companies are given a fresh start, effectively achieving one of the primary public policy objectives of Chapter 11.

    Having watched thousands of distressed companies over the past 22 years, the difference between a company that survives and thrives, and those that flounder and eventually flop, is where management puts its skill and energy.  Those that focus on acquiring additional resources – capital, access to new markets, additional skills and talent, financial acumen, etc. – emerge stronger.  Those whose sole focus is completing a plan of reorganization without securing additional resources generally fail.

Law 360, The Newswire for Business Lawyers (http://www.law360.com/subscribe) recently reported:

Constar Enters Ch. 11 Again With Plan in Hand
Plastic bottle maker Constar International Inc. on Tuesday filed for Chapter 11 bankruptcy,complete with a prepackaged reorganization that will slash up to $150 million in debt, less than a year after emerging from court protection.

Retailer Anchor Blue Returns To Ch. 11
Following a 2009 restructuring retailer Anchor Blue Inc. on Tuesday again turned to Chapter 11 bankruptcy protection, this time to carry out an orderly liquidation of its 117 stores.

    Similar examples of repeat filers abound.   The mere fact that companies file a second time is evidence that the reorganization plan itself did not fix the underlying problems.   The plan may prolong life, but the underlying illness that led to the first bankruptcy will resurface again soon enough if additional resources were not obtained.    Small and mid-size businesses simply cannot survive these repeat filings, dubbed “22s” by the pundits (two times 11).  Management must count on counsel and other advisors to guide them through the Chapter 11 process while they must focus on running the business and bringing in additional resources as quickly and efficiently as possible.

    In this particular instance, the owner concluded that everything possible had been done to improve the business.  While this is generally the case, as we conduct our analysis we often provide recommendations business owners find effective.  While our partners have significant management expertise, management consulting is not our core business so generally these types of recommendations are provided without charge.  We see it as a natural outgrowth of our process and simply the right thing to do for our clients.

    This particular client had also determined that further attempts to restructure the loan with the existing creditor would be fruitless and, in this case, we agreed.  In other cases, we have found that creditors may well consider restructuring if a 3rd party has given them a true, real-world assessment of their situation.   In these challenging economic times, creditors are often simply too busy to fully assess their situation and appreciate accessing other professionals’ expertise.

    In this instance, we had to tell this client that refinancing was highly unlikely.  We knew the market and the players and did not believe anyone would refinance the loan with favorable terms.  This was harsh medicine, but it is critical to face challenges head on.  There appeared to be a possibility of restructuring the existing lender’s debt via a plan of reorganization, but it needed to be bullet proof.  The creditor was fatigued, aggressive and prepared for battle.

    Securing an equity infusion would be highly unlikely in this example as well because additional financing would be needed to further develop the business and make it profitable.  No one could be expected to put in additional equity without a clear path to additional financing, which simply was not available for this business.

    This particular client would benefit most from a comprehensive sales and marketing process.  Like most owners, they had had discussions with potential investors and they knew their business concept and plan would be successful if they could escape distress.  

    A planned, structured, scheduled, exhaustive sales and marketing process has four primary benefits:  1) The process may yield a price that satisfies creditors and offers an attractive return for equity holders; 2) If the owner has access to capital, he may be able to buy the company back at an attractive price, debt free; 3) Crystallizing the process brings potential investors who had previously talked about contributing capital to the table; and 4) The owner is introduced to a wide array of potential buyers/investors and is free to join forces with them.

    Liquidating is almost always an option of last resort.  If there really aren’t any prospects for the business, agreeing to liquidate and maximize the value of what is left for creditors is often helpful with obtaining relief from personal guarantees.  While we can maximize the value of assets in liquidations and have had good success obtaining relief from personal guarantees, our interest lies in keeping businesses open, saving jobs, and providing opportunity for recapitalized, strengthened companies to realize their potential.

    If you would like a blank copy of this tool for your own use, please email Dan Rexford at drexford@EquityPartnersInc.com .

In year one: 

• 72.7 percent of companies who had reorganized missed their sales projections;
• 62.7 percent were below their projected net income; and
• 63.2 percent were below their projected cash flow from operations.

Of those who survived to year two: 

• 66.7 percent missed their sales projections;
• 71 percent were below their projected net income; and
• 57.1  percent were below their projected cash flow from operations.

Of those who survived to year three: 

• 68.2 percent missed their sales projections;
• 72.7 percent were below their projected net income; and
• 58.8 percent were below their projected cash flow from operations.

Clearly, filing a plan of reorganization and achieving confirmation, a lengthy and expensive process unto itself, is no panacea.  Distressed companies need resources – access to a market, capital, additional skills and talent, etc. – to survive and thrive.  Acquiring these resources as quickly, efficiently, and inexpensively as possible must be management’s focus.  Striving for a plan of reorganization may be the right course but it cannot be the goal.

The geography we covered last year was pretty diverse as well.  We worked for clients in the Midwest, Northeast, Mid-Atlantic, South, and in Canada.  Creditors we worked with ranged from private funds to traditional banks to families who committed their own resources to their businesses.

Some common themes emerged from among the reasons these firms found themselves needing a quick infusion of capital.  A few were simply mismanaged.  They failed to control costs, had lost their focus, didn’t provide distinguishable products or services, forgot to do the blocking and tackling, etc.  Some were simply victims of the economy.  They lost top line revenue and could not reduce expenses enough to keep going without additional capital.

Others were caught in a more frustrating trap.  They had been riding the economic wave and expanded in 2004 through the first half of 2007, most frequently by taking on more debt.  Loans were relatively easy to come by, top line revenue was growing, margins were strong – in short, every indicator they could see was telling them it was time to invest and add capacity.  Then the economy tanked, sales slowed, and they found themselves over leveraged.  In many instances, these are good companies, well managed yet they find themselves long on debt, short on cash and needing new money.

The good news is that no matter what reason they had for calling on Equity Partners we were able to find a lot of people willing to pour money and resources into these companies.  In fact, on average, 33 groups responded to our sales and marketing programs, executed Confidentiality Agreements, and downloaded documents from a Virtual Data Room for each engagement.  In most cases, we had conference calls with management and site visits within two weeks of launch.  And, we were getting offers in 6 weeks.

Both financial and strategic investors responded.  Savvy investors moved quickly, ascertained underlying value and acquired stakes in some very nice businesses.  In some cases, these investors needed to put out a large amount of cash because securing financing is still tough.  In others, the cash outlay was not as significant but the investors were going to be putting management expertise, back office shared services, sales and marketing resources, etc. to work to improve the company.

What is heartening, and bodes well for 2011, is that there are investors who are looking for opportunities in all types of industries throughout the country.  By creating and executing robust sales and marketing plans and turning over every stone, we were able to create a competitive environment to maximize value on each and every engagement. We are proud of the economic outcome our work provides but we are prouder still of the jobs we help save by closing transactions that strengthen companies. 

While the U.S. economy certainly isn’t out of the woods yet and there is surely more pain to come, we are seeing the investors come off the sidelines.  We expect to see more of the same in the coming year and as the economy improves we expect to see more competition for a chance to invest in these companies.

We appreciate our relationship and thank you for your support throughout the year.  If there is anything Equity Partners can do for you, please don’t hesitate to ask.

We wish you health and prosperity in 2011 and look forward to talking with you.

Unfortunately, your list doesn’t end there.  You have another constituency that simply must be handled well – your customers.  Lose your customers and the jig is up.

You built a business by being proactive and facing reality.  You can rely on those traits now.  If you are executing a real plan, you will be seeing to it that real options are going to be put on the table in a manner of weeks.  You aren’t playing roulette, hoping that red 46 comes up.  You will be selecting from Option A, Option B, Option C, or Option D.

Communicate that plan in the right way to your customers and you will solidify your position and enhance your image.  Fail to be executing a plan or dodge the communication and you might as well be waiting for a spin from the croupier.

1.  WHAT TO SAY?

Your goal is to reassure your customers.  Assume that ugly rumors are already making the rounds.  You want to let your customers know that they are of paramount importance, quality isn’t slipping, your company will be there in the future, and, in fact, the company will be better than ever.

How do you do that?  Tell the truth, attractively.

Equity Partners provided the owner and everyone on the management team of a teetering health care company with this elevator speech:

"We want to continue to be ahead of the curve so we can offer you the very best combination of speed, quality and price.  We’ve analyzed our business and believe we need some additional resources to continue to stay ahead of the curve.  We’ve retained an investment banking firm to help us explore all of our options.  They will be conducting a broad campaign and you may well hear about it.

I just wanted to give you a heads-up so you know what is going on.  We see a lot of opportunity in front of us but we need some additional capital to take advantage of these opportunities.  Obviously, our relationship is important to me and I didn’t want you wondering about things.”

The results outstripped our high expectations.  They not only maintained all of their customers, they landed new ones by incorporating some of the key points of this message into their sales presentations.

Why did this message work so well?  The simple answer is that we told the truth, attractively.  Dissect the message and we can learn a little more:

   -  "ahead of the curve" portrays the company as an industry leader.

   -  "best combination of speed, quality and price" reiterates the company’s brand promise.

   - "analyzed our business" demonstrates that management is on top of their game.

    - "see a lot of opportunity in front of us" subtly communicates that we will be there in the future.

    - "our relationship is important to me" directly addresses one of our objectives.

Every situation is unique but the principles of good communication are universal.  Think deeply about your situation and develop your message for your customers.

2.  HOW TO SAY IT?

Your role:  Categorize your customers and establish a simple communications plan.  Personally deliver the message to all of your key, top-tier customers.  It is the best use of your time.  You are most likely to be successful and there is no better opportunity for you to learn what your customers are thinking.   Don’t leave your key customers in the hands of others.

If you have major repeat customers and can get there quickly, go see them.  Nothing replaces a face-to-face meeting. We recognize that schedules and logistics may make in-person meetings with some customers impossible.  If so, make a phone call.

Key management’s role:  Reinforce your message with top-tier customers and communicate with second tier customers that you do not have time to personally address.  Again, favor in-person meetings with phone calls as a substitute.

A word about email --  Email is too easily forwarded and often misconstrued.  For third tier customers, where even a phone call is too difficult, send a simple, straightforward letter.

Deliver the right message in the right way to your customers and they will continue to have confidence in you and will continue to buy.  Effective communication isn’t rocket science but going ‘radio silent’ risks losing it all.  Authentic leadership requires moving forward and communicating with confidence.

And, please remember to go back to these same customers after you implement a solution.  They will be excited to hear about your renewed vision for your shared future and they may well increase their commitment on the spot.  

Cash Flow.  If companies are machines, cash flow is the fuel.  A company can have positive EBITDA, but negative cash flow.  That company is in trouble.  The situation can result from a variety of factors, but the most common in today’s economy is excessive debt.  These balance sheet problems can be some of the easiest to fix and can often be dealt with by restructuring negotiations with the company’s lender(s).  Terms can be extended and interest payments can be reduced, or temporarily eliminated, allowing the company to restart the engine and get back on their feet.  In other cases, a sale of assets to a “NewCo” is the way to clean up the balance sheet, and in others, bringing in new equity solves the issue.  If the cash flow problem is so deep that there is no EBITDA, one or both of the following two classifications probably apply.

Operational or Micro Problems.  Management is hard pressed to recognize this one, or to admit it, but many troubled companies suffer from simple mismanagement.  Unused capacity, process bottlenecks, excessive SG&A expenses, high material waste, aged receivables, quality issues, poor margins, and labor issues are all signs of operational failures.  The result of such issues may well appear as negative EBITDA on the income statement.  While the fix may be easily found outside of court in some companies, larger deep-rooted problems may be better solved through the use of bankruptcy protection.  In some cases, these problems can also be fixed via a joint venture or by partnering with a synergistic partner, or with the help of management consultants.

External or Macro Problems.  External problems are commonly cited as the cause of distress.  While it may be, management has a tendency to lean on this crutch more than any other.  Nine years ago, every distressed company said, “it was 9/11,” then we heard “along came Katrina,” and now “it’s the recession.”  And of course, there is “China.”  Many companies were and are seriously affected by these outside events, but many more are claiming to be, and the macro external event is just exposing the micro distresses that were already present but hidden.  If indeed external problems are the cause of a company’s trouble, one must evaluate whether that problem is a one-time event or if it is a new trend that will likely affect the company/industry going forward.  Depending on the magnitude, the one-time event can generally be handled with relative ease.  The macro problem that indicates a new trend may signal that there is no longer a place for the company in the future and an orderly wind down of the company may be in the best interest of shareholders and creditors.  In some rare cases, depending on the type of business and the type of macro event, the business may be sold to someone who can transition the assets of the company into other more productive uses.

Legal Troubles.  Some could argue that this is a subset of “External Problems,” and it may be, but the solutions are so different that it deserves its own category.  Many businesses, and in fact many industries, operate in an extremely litigious environment.  Energy companies, chemical manufacturers, pharmaceutical companies and the like deal with a constant barrage of lawsuits.  In many cases, one or more of these lawsuits can hamper a company’s day to day operations and force them to file for bankruptcy protection.  The automatic stay provision of the bankruptcy code will stay almost all legal action and allow the company the ability to propose a plan of reorganization that outlines how litigants will be treated, in some cases as non-consenting litigants.  Alternatively, a sale of the business, via an asset sale, with or without equity participation for “OldCo’s” shareholders, can get the underlying business freed from the litigation. 

Clearly, properly evaluating the nature of a company’s distress is key to implementing a solution.  Every situation is slightly unique and many troubles can easily be misdiagnosed as another.  Regardless of the type of distress, swift action must be taken.  We often liken a distressed company to a melting ice cube; not acting immediately will ultimately result in not having anything left to work with.  Evaluate your situation and react quickly.

Author’s Note:  While the ideas in this article are broadly known among insolvency professionals, and the terminology / classifications are not unique to any one author, we’d like to credit Kelly K. Frazier, the Principal Author of  “A Comparison Shopping Guide for 363 Sales,” and who outlines these concepts in that book.   To that basic outline, we’ve added our own thoughts and experiences.   The book can be purchased at:  www.abiworld.org/abistore.

Chances are you are already paying the piper – higher prices, poor delivery terms.  You may be headed for C.O.D.  Worse still, tongues wag.  Many people seem to revel in others’ misfortune and grab any available ear.  Dangerous stuff.

1.  What to do?  Communicate.  Tell the truth, attractively.

That does not mean broadcasting:  “we’re in trouble, please be patient.”

2.  What to say?  If you are facing reality, you are seeing to it that real options will be on the table.  Tell your vendors and suppliers that and you will earn their respect and enhance your reputation.

For example, we wrote the following “talk track” for the CEO of a manufacturing company we worked with:

“I want you to know that we are in the process of adding to our resources to seize the opportunities in front of us.  We’ve analyzed our business and believe we need some additional resources to continue to stay ahead of the curve.  We’ve retained an investment banking firm to help us explore all of our options.  They will be conducting a broad campaign and you may well hear about it.  I just wanted you to know what is going on.  We see a lot of opportunity in front of us but we need some additional capital to take advantage of it.

Our goal is to grow our business, and, when we grow, you grow.”

Feedback was positive.  The rumor din decreased.  Some people even asked if they could help.

3.  How to deliver the message?  While email is easy, it is too easily forwarded and often misconstrued.  We recommend phone calls or letters.  While it may be impractical to call all but the major vendors and suppliers, call as many as you can.  Phone calls are the quickest, surest way to quell the rumor mill.  Send the rest a simple, straightforward letter.

4.  Who should deliver the message?  Ideally, you.  Second best would be someone else on your management team.  While there is plenty to do, keeping raw materials, supplies, and services coming is important work and you want it to be handled right.

You are in control – getting real options on the table quickly.  Communicate that to your vendors and suppliers and they will work with you through the tough times.  And, you will be well positioned to demand better prices and a higher level of service when you implement a solution.

Good communication with employees is always important but it is absolutely critical when your company needs a quick infusion of capital.  Your employees know resources are tight and can sense that there may be trouble.  They are watching your every move, trying to put the puzzle together.  Now is the time to step up and tell the truth attractively.

What you are trying to mitigate is employees’ fear of the unknown, a feeling that ‘my destiny is being determined by others and I’m a pawn.’  Even though it may be obvious to outsiders and management that an influx of capital will improve the company, your employees probably don’t see it that way.  In the absence of communication, their perception is likely to be:  ‘Change is coming.  I’m losing control.’ 

An overwhelming number of studies demonstrate that employees who feel they are not in control of their work and workplace are demoralized and perform poorly.  You need everyone going the extra mile and can’t afford poor morale and the attendant poor performance.  The key to keeping your employees engaged is frequent, coordinated, consistent, straightforward communication. 

Make them feel like they are part of the solution and they will continue to deliver and a few outstanding people will even raise their game.  Keep them in the dark and tongues will wag, little work will get done, and people will spend their time wondering if they shouldn’t be copying their resumes.

1.  TECHNIQUES

A.  Communication should be delivered by the leader and seconded by the other major players on the management team (formally and informally).

B.  Provide frequent updates.

C.  Be brief -- Maybe 9 minutes and then get back to work, much longer and people will think that their job is to speculate about the future.

D.  Communicate in-person or via conference calls, if necessary.  People need to hear the voice.  Unless you have used video-conferencing before, now is probably not the time to start – the mechanics can get in the way of true communication.

E.  Do not lean on emails; they can be easily misconstrued, forwarded, etc.

F.  Management needs to avoid closing the doors to their offices as much as possible – closed doors scare and distract people – “what is happening back there?”

G.  Answer questions quickly and truthfully, imparting an optimistic outlook.  Tell the truth attractively.

H.  Make sure employees see management planning for the future, preparing for growth, talking about growth.

I.  Communicate a sense of purpose with your actions/demeanor.  Think of it this way:  be quick but do not hurry.

J.  Make sure everyone sees you smiling and laughing.  All eyes are on you, searching for clues, wondering if they should avoid being the last rat on the ship.  Smiling and laughing imparts confidence.

K.  Celebrate any wins.   Don’t overdo it; but when someone makes an important sale or finishes a job or solves a problem, make sure people know about it, give 90% of the praise to the lower level people, and pat the managers on the back for doing such a fine job of leading.

L.  Say the same things over and over and over again – repetition is comforting, you are not insulting them, they only hear 5% of what you say anyway.

2.  MESSAGE

A.  Establish context -- Summarize the company’s history and achievements.  Put it in big picture terms, emphasizing the softer side.  Give all of the credit to the employees.

Here is an example from a message Equity Partners wrote for the CEO of an energy services company:

“You have built a tremendous business over the years – we’ve served hundreds of customers and affected tens of thousands of lives.  When I think about how many employees, school kids, hospital patients, doctors, nurses, etc., etc. are more comfortable because of your work, I believe it is a tremendous contribution.  And when you add in the fact that you save our customers money, strengthening their financial position, you are really doing something, particularly in this troubled world economy.  And when you layer the significant impact you have had on the environment on top of that, I can’t help but to feel privileged to work alongside of you.”

B.  Be specific about contributions, giving examples -- Identify and summarize the contributions of each working group, being sure to be positive.  Mention them all.  Do not overlook anyone.  A few examples:

“The Controls group has built a portfolio of repeat customers over the years.”

“Without growing, our Accounting and Administrative group has been able to keep up with a 10% increase in the number of orders.”

“The Service team does the day in and day out work that keeps our customers coming back for more.”

“The engineers in Energy Services keep on top of changes in their field and are now handling solar measures, opening up a new market for us.”

“Our Sales team added three new clients last month.”

Fight the urge to add the “buts” in these communications.   There are plenty of opportunities to say “we need to do more and do better.”  With these communications, remember your goal:  keep them comfortable with your leadership and inform them that you are in control and are dealing with the problem proactively.  Leave your remarks positive, resisting the urge to add “but we lost the Continental account” to the sentence “Our Sales team added three new clients last month.”

C.  Explain – Tell them what you are doing and why.

“As you know, we are recapitalizing the company.  We need more resources to take advantage of the opportunities in front of us.  You have built the foundation, now is the time to build on it and provide you with the platform you need so you can go as far as you want to go.”

“What are we looking for?   one word:  opportunity.  What do I mean by opportunity?  Two things:  money and growth.

(1)  Let’s face it, we need some more money.  We’ve worked hard to get as much money as we can into your hands over the years.  That means we have been stretching things, asking the people who supply us with goods and services (the people who aren’t in this room) to be patient, to trust us, to take their payment when we have the money.  We’ve rightly put you first and I feel good about that.  But, you can’t keep asking the people you have to buy things from to be patient forever and I really didn’t want to ask you to take pay cuts.  We need some additional resources.

(2)  Growth.  I learned a long time ago that you can’t stand still … you are either growing or shrinking.  I don’t know about you, but I prefer growing.  Selfishly, I want more opportunity to do more, to do different things, to join you in taking this organization as far as we can.  And I want that for you.  To do that, we need to add some resource, maybe some additional connections, some additional skill sets.”

By addressing both money and growth, you have set the stage for all possible outcomes – refinancing, equity infusion, joint venture or a sale. 

3.  FREQUENCY

Update your team frequently, at least once a week.  Continue to communicate in positive terms.  For example:  “Thanks to the reputation you have built, 21 different groups have already responded and are taking a hard look at making an investment in our company.”  Err on the side of too much communication rather than two little. 

You are proactive and in control – getting real options on the table quickly.  Demonstrate that through your communications and your employees will work with you through the tough times and will be well prepared to seize the opportunity of working for a strengthened company when it is recapitalized.