We Should Have Listened

 

This article, by Revitalization Partners, was first published in the ABL Advisor.

Nine months ago, Revitalization Partners began hearing of ominous warnings from management insiders, many of whom were forecasting a 2020 recession.

It was not that startling to us, given that we had written about the factors that could produce a downturn in various blog posts. However, those collective observations were running counter to the news of the day.

The country was doing great – experiencing full employment, confident consumers, a robust housing market and low interest rates.

To be fair, there were signs of headwinds as well, such as the government’s obsession with imposing tariffs on our trading partners, an upcoming presidential election and considerable uncertainty To in the stock market.

The issue at the time was if and/or when companies started to cut back on spending and reducing inventory levels, those emerging challenges would serve as the forewarning of economic problems to come.

 

OTHER TROUBLING SIGNS …

Other troubling signs started to surface: In late 2019 a Fortune/Survey Monkey surveyed senior managers at companies ranging from Fortune 500 concerns to small businesses in diverse industries.

One of the key findings was that two out of three executives believed a recession was likely within the next twelve months.

While there were several bright spots in the economy at the time, the consensus was that the good times would not last forever.

Coincidentally, it was December 2019 when the first COVID-19 case was reported in China and by the end of January 2020 the World Health Organization declared the highly transmissible virus a global health emergency. The first case in the USA was reported in January as well.

As it turns out, the concern that managers had in late 2019 would translate into a major transformation and upheaval of business much sooner than even they had predicted. A number of key economic indicators essentially crashed in a remarkably short period of time.

The Dow Jones Industrial Average dropped 38% in 40 days, unemployment soared from 3.5% in February to 14.7% in April, and consumer confidence plummeted 29% from February to April.

 

MOST BUSINESSES WERE UNPREPARED …

Most businesses were unprepared to deal with the economic free fall.  In fact, small- to middle market companies experienced the most significant declines and were generally ill equipped to deal with them.

In retrospect, one might ask what could these businesses have done to prepare for such a drastic downturn? 

Given the dramatic rate of change, some might question what, if anything, they could have done to mitigate the financial impact.

Our response to that rhetorical question has never wavered: Always have a Plan B – even in good times.

In the world of business, where both startup and established companies deal with daily struggles and sometimes risk everything to succeed, having a Plan B may be considered a weakness or seen as a lack of commitment to the current plan.  

Having a contingency plan is nothing new, however, especially to those organizations and individuals willing to take great risks for a chance at even greater gains.  

Dating back to the Civil War, the art of contingency planning took on supreme importance in case the optimal plan of attack did not work out.

 

VIEW AS A STRATEGY …

Even though you hope that you will never have to resort to your back-up plan, this does not change its importance since you might have to rely on it in the future.

The process itself will often cause you to rethink your primary plan and be in a position to improve it.

Intentionality is what makes any contingency plan effective.  Executives who are often risking it all to survive in the business world, regardless of sector or industry, should view their back-up plan as a strategy, not an afterthought.

It requires you to take a personal inventory of what is important to you and finding ways other than Plan A to help achieve your goals.

 

CRITICALLY ASSESS YOUR BUSINESS …

The last point is particularly important, as developing a Plan B forces management to assess their business critically.   As part of this process, they must understand where they have vulnerabilities.

This might include assessing the risk of high customer concentration, weakness in their supply chain, determining the risk of losing key management members, the lack of online ordering and delivery systems, as well as weakness in their information technology systems.

By identifying these vulnerabilities, management in fact may decide they must take action sooner, rather than later, to make important changes in advance of the next business decline.

Take it from former CEO’s that have helped numerous companies deal with the consequences of poor planning: You don’t want to be the person in the board or management meeting that says, “We should have listened – and been prepared!”

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Understanding the Small Business Reorganization Act

With Covd-19 and the differing attempts by state and local government to contain the spread by various regulations, smaller companies in the almost every industry have often been negatively affected by state regulations.

As a result of states where small business has been affected by COVID regulations, some companies may find themselves of the brink of insolvency.

Until recently, there have been two chapters of the bankruptcy code for the use of insolvent companies: Chapter 11 and Chapter 7.

 

TWO PATHS YOU CAN TAKE …

Chapter 11 was designed for the restructuring of companies that have a future business.  Chapter 7 is designed for the liquidation of companies without a projected future due to market forces or excessive debt.

For a smaller company, Chapter 11 is often far too expensive.  It requires a source of significant cash and a plan that has been worked out far in advance. 

Chapter 11 professional fees can begin at $100,000 and for a mid-sized company can become five times that figure. Most financially distressed small and mid-sized companies have neither the cash to support the fees nor have done the planning.

 

IN 2019 CONGRESS CREATED …

In August 2019, congress created The Chapter V subsection of Chapter 11.  Known as the SBRA or Small Business Restructuring Act, it is designed to let smaller companies take advantage of bankruptcy restructuring laws in a way that is both faster and less expensive.

To be eligible for Subchapter V, a debtor must be engaged in a commercial activity and its total debts must be less than $2,725,625.

The new CARES act has temporarily (for one year) has expanded that debt level to $7,500,000.

This increase allows larger companies to take advantage of Chapter V. Upon filing its bankruptcy petition, the Chapter V debtor must also file a balance sheet, statement of operations, cash flow statement and federal tax returns.

 

MORE LIKE AN ADVISOR THAN A …

The court will appoint a trustee.  The Sub-chapter V trustee does not take possession of a debtor’s assets and lacks the ability to sell those assets. The trustee is more like an advisor and handler; facilitating the development of a consensual reorganization plan, appearing at hearings, and ensuring that the debtor makes timely payments under the plan. The debtor must also pay the trustee.

The Chapter V process moves at light speed by traditional Chapter 11 standards. The court will hold a status conference within 60 days. At least 14 days prior to that conference, the debtor must report, in writing, the efforts made and to be made to obtain consensual plan.

The debtor and only the debtor must file its plan of reorganization within 90 days of the filing. The plan must include a brief history of the business operation, a liquidation analysis and financial projections demonstrating the ability of the debtor to make the proposed plan payments.

 

CREDITOR ACCEPTANCE NOT REQUIRED … 

To get a plan confirmed in Chapter V, it does not require acceptance by creditors.  It must not discriminate unfairly and must be fair and equitable.

Creditors must receive as much as they would if the debtor were liquidated in Chapter 7. 

Subchapter V includes an option for the debtor to contribute all “projected disposable income” to making plan payments for three to five years. 

Projected disposable income is everything after expenses to maintain and support the debtor and expenses necessary for business operations.

This provides an advantage to creditors to whom the debtor owes money and doesn’t have the ability for immediate payment but is projected to have the funds over the life of the plan.

 

A REASONABLE LIKELIHOOD …

To confirm a plan, the court must find that the debtor will be able to make the payments ordered under the plan or there is, at least, a reasonable likelihood will be able to make the payments under the plan and the plan has appropriate remedies to protect the creditors is payments are not made as proposed.

The SBRA contains many other provisions. A debtor’s attorney and the trustee can help ensure that the filing and plan are compliant with Subchapter V.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Taking a Break

Over the past number of years, Revitalization Partners has taken the month of August away from our semi-weekly blog.

This year, however, with the Covid-19 issues, moving from our Seattle office to coordaining working from home and making certain that we helped our clients who were also going through similar changes, it appears that the month of July got away from us as well.

We are announcing a slightly longer vacation from our blog this year and our plan is to be back in September. All of us at RP wish you and your families an enjoyable and safe summer and are looking forward to resuming our writing in September.

All the very best,
The RP Gang

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Re-engineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Real Estate Turnarounds to Consider First

 

Although it feels like an eternity, we are only three months into the coronavirus recession and most owners and lenders are still thinking in terms of “blend-and-extend”.

Nevertheless, three kinds of real estate investments need more active intervention now or they are likely to face much greater losses later.

 

 

THESE USUALLY NEED EARLY INTERVENTION

1. Hospitality Properties.

No recession or depression in the last 100 years has come so fast and so utterly stopped travel, not only in the short term for vacations and business trips, but longer-term for conferences and conventions.

Tourism towns like Ashland, Bend, Chelan and Leavenworth have already lost their shoulder seasons and are now losing the group bookings that keep them alive in the fall.

The outlook for conference hotels in downtown Seattle, Portland and at Sea-Tac is slightly less bleak. Some properties are likely to have difficulty covering not only their debt service but their general and administrative expense.

2.  Senior Housing

The second type of real estate suffering acutely is senior housing, especially assisted care homes. 

These facilities turn over about four percent of their occupants a month, but now they must convince prospective residents not only to “give up their independence” and move out of their homes but face the health threat of group living.

The break-even for many is about 75 percent occupancy, but within six months many could down to 50 percent. Smaller, more thinly capitalized companies may soon be unable to pay salaries.

3.  Land-Development Deals

There are land development deals that were already in trouble before the pandemic. 

The last two years a number of new developers and investors entered the market, overpaid for property and underestimated the length of the approvals process, often for urban infill projects in big cities, low-end lots on the metropolitan fringe and second home lot subdivisions in recreation destinations.

Being newest to the business, these developers and investors are the least able to work them out.

 

DROP FARTHER & FASTER …

In most recessions, real estate values drop farther in value and for far longer than most people expect.

While it probably makes sense to finish most projects now in construction, land deals should be liquidated as quickly as possible, since these usually lose proportionately far more of their value than more developed real estate.

 

FEWER BUYERS WITH LESS CASH …

There will be far fewer buyers with the necessary cash and operational expertise for senior housing and hotels, but their numbers, too, will drop as the recession bites deeper. 

Unless you can ride out the recession long term, act now while values are higher, and you have more options.

“Recognizing your problems early will enable you to recover more of your investment.”

That means finding skilled people you can trust to realistically identify conditions, assess what actions will immediately add value, and then manage the sale or liquidation of the property.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Emotion in Commercial Real Estate

 

There is no doubt that real estate turnarounds can be laden with high emotion and drama.

Dealing with that emotion and drama usually requires more experience and energy than all the technical challenges of real estate, no matter how good or bad the market conditions are.

But…there are tools that can be used with this social side of real estate. 

This blog post describes two that have worked in several situations involving large properties.

 

A LOT OF EMOTION …

It is important to recognize that the nature of real estate means that there is frequently a lot of emotion tied up in it.  First of all, it is tangible, and property is often a symbol of success.

The warehouse in question may be where Granddad started the family business.

The new office building was to have been the shining new company headquarters.

That high-rise apartment building was going to be the best in town.

 

ALMOST ALWAYS INVOLVES DEBT …

Second, real estate is capital intensive. 

Its development or acquisition almost always involves debt, and the equity partners are frequently family or friends who have invested on faith. 

There may be personal guarantees out to banks or lenders.

And the individual who made the loan may be fearful about losing his or her job should anything go wrong.

 

LONG AND INVOLVED PROCESS …

Third, compared with many kinds of business activity, real estate development is usually a long and involved process, one that requires progressively more time and emotion as you move through it.  

Ask someone about the progress of their project, and they probably have a rendering of it stored in the corner ready to pull out.

They might have spent a long day sitting and waiting to testify at a planning commission meeting, or have held a shockingly expensive groundbreaking event.

The marketing materials probably shine with a story yet to be realized.

 

AN UNCERTAIN FUTURE …

By the time there is need for a turnaround, all these hopes and ambitions are still present, but now the future is uncertain and holds fearful prospects.

Who wants to let go of their dream? People can feel alone and trapped.

What is offered here may sound like two very modest tools for use at the very beginning of the turn-around process, when all these emotions are at their peak, things are most uncertain, and there is not yet a path to the future.

Together, however, they begin to create that path to the future, one grounded in the past and present.

 

TWO HELPFUL TOOLS …

1. A DETAILED HISTORY:  The first is writing down a detailed history of the project, usually filling up a page or two, that provides a chronology of who did what when and with how much what money.

This might include, for example, the date and amount of the first option payment, when purchase of the property closed and with whose funds, how much was spent on planning and approvals, the cost and length of construction, and the various lenders involved.

It sounds simple but writing this history can be both useful and therapeutic.  Beyond the fact that the receiver or others will need it, this history requires a detailed sharing of information, something many that borrowers living in fear may have grown loath to do.

This tells their story, both the good and the bad, and puts different issues in perspective. This history also tells you what technical reports you can now store away not worry about.

 

2. A PROFORMA MODEL:  The second tool is a pro forma model of the sources and uses of cash for the project.

This shows, over time, where the money came or will come from (such as equity, debt, operating income and disposition), and what it has been or will be used (such as land acquisition, design, construction, leasing and loan repayment.)

Ideally, this is all one page, and probably covers somewhere between two and five years of cash flows.

 

REMOVE EMOTION …

The fact that this is a table of numbers itself takes some of the emotion out of the discussions. There is no architect at the table to defend his plan, no broker eager for a steady stream of leasing commissions.

Putting together the numbers does require the borrower and lender to quantify their assumptions about what will add value to the project, what it will be worth at various stages of completion, and how long things will take.

That, in itself, moves the discussion from the past to the future, from “Where did I make a mistake?” to “How do we move forward?”

 

EARLY STAGES …

We are now in the early stages of a recession that, according to many in real estate, we were due for a year or two ago.

Because the onset was so abrupt and the future is so uncertain, emotions are going to run higher than ever on distressed real estate.

The borrowers and lenders that can come together now and work out a strategy will have more options and will recover more than those who wait.

These tools are one way to deal with the emotions that often keep people from starting that process.

 

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Rod Stevens Introduction

 

Revitalization Partners is pleased to announce that Rod Stevens has joined the company as a Senior Director.

Rod has worked in the structuring and restructuring of commercial real estate for almost 40 years and through four previous recessions.

He has planned and financed a number of innovative new projects and solved problems for those that needed assistance.

His skills include market research and financial analysis, due diligence investigations, project programming and planning, financial underwriting, and turnaround management.

Rod’s experience includes work with financial institutions, developers, and high net worth individuals. As Vice President of Portland-based Wyse Investment, Rod negotiated and placed real estate investments on behalf of the Stoel Rives, Les Schwab and other regional pension funds, as well as a number of high net worth individuals.

After the savings-and-loan crisis, Rod helped a bank create liquidity from its holdings by structuring a cash flow mortgage backed by the restructured loans on 75 Texas properties.

For more than 30 years, Rod has worked at a board room level on the use and workout of real estate, serving as an advisor to senior executives in both decision making and turnaround execution. His experience includes:

• Port Quendall, Renton, WA: Microsoft co-founder Paul Allen’s staff had spent more than $20 million planning an 80-acre, mixed-use development on a waterfront brownfield site in Renton. Rod managed a PR crisis with city and state leaders who had invested in the old plan, negotiated a final agreement with environmental regulators who tried to re-open a court-ordered settlement, stopped the acquisition of a neighboring site with even worse pollution problems, and met with Allen to provide a detailed accounting of where the money had been spent.

• Kenmore Village, Kenmore, WA: The client had spent about ten years and $10 million trying to turn an old shopping center into a lifestyle mall with upscale retailers. Pre-leasing was unsuccessful, and the development partner walked away when the 2008 recession struck. To draw a broad response from possible buyers, he prepared a briefing book with a detailed discussion of site issues that saved them time on due diligence investigations. When taken to market, the property drew 12 solid offers. The client fully recovered their investment and the site was developed with approximately $100 million of new apartments, restaurants, office, and public space.

• 888 Blvd. of the Arts, Sarasota, FL: A Dutch pension fund had taken back a 300-unit high-rise condominium project which it had invested in five years before. The fund had also tried to fix construction problems three times, unsuccessfully, angering homeowners who were about to sue. Taking over the project, Rod recruited a team of construction, marketing, legal and management talent to determine a turnaround solution. Rod carried out the solution opening a new sales center even as the turnaround work was occurring while keeping owners in their units. In two short sales seasons of five months each, the project was completely sold.

Rod’s background and experience adds significant depth and breadth to Revitalization Partners team of Senior Executives and brings a laser like focus in solving both financial and operational difficulties in real estate projects.

Rod’s educational background includes a BA in history from Stanford University and an MBA from Dartmouth’s Amos Tuck School of Business.

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Watch Out for Zombie Companies!

 

The term Zombie company was originally used by Japanese media around 1990, to describe companies with large historic debts that ultimately failed and resulted in the country’s 1990 market crash.

The definition of Zombie companies relates to businesses that are highly leveraged, and are generating sufficient cash to fund operations, however, are not able to repay their debt when due.

Their lenders and/or investors continue to support these companies by granting forbearance or by extending repayment terms in hopes that the business outlook will improve.

The real truth is, those companies are in effect insolvent, or dead, and therefore become Zombies.

 

ONE COMMON DENOMINATOR …

Zombie companies come in many forms. They can be startups funded by venture capital firms, family businesses, privately-owned companies, or companies owned by private equity firms.

While Zombies come in all shapes and sizes,
there is always one common denominator,

high debt leverage relative to cash available
to fund operations and debt service.

 

A recent article in Forbes magazine highlighted that corporate debt of large nonfinancial US companies is nearing $10 trillion and small, medium, family, and other businesses not listed in the stock exchanges carry an additional debt of $5.5 trillion.

The total of nearly $15.5 trillion, results in an average debt to equity ratio of 84%. 

A recent CNN article written prior to the COVID-19 crisis revealed that 1 out of every 8 companies in advanced world economies met the definition of a Zombie company.

 

THE COVID-19 CRISIS HAS …

Regardless of the reasons for highly-leveraged companies, the COVID-19 crisis has significantly increased the number of Zombies, although there have been no recent statistics showing how many more companies are almost dead.

The central focus here is that while the number of distressed companies has accelerated since the beginning of the year, what can and should be done to deal with this growing epidemic?

 

 

THE 1ST QUESTION TO ASK …

The first question that has to be asked is can the Zombie be resuscitated?   Can it be brought back to life? 

This question requires that the responsible fiduciaries make an assessment of the company’s viability.

In other words, is the company better off alive or dead? 

It is a common truth (at least with companies we worked with) that life-threatening problems are not always dealt with in a timely manner.

Typically, resolutions to operating problems are pushed off, in the hope that things will get better although they usually do not. This issue always compounds the problems and in today’s environment, the term “Hope is Not a Strategy” is even more relevant.

 

RESPONSIBLE PARTIES MUST ACT …

An honest assessment is required by the responsible parties to make this determination.  And an honest assessment includes a thorough and objective evaluation of the company’s near-term prospects.

When you are a Zombie, it does not help to look at the long term!  Responsible parties should also seek outside help in assessing the near term prospects, to ensure objectivity.

If, at the end of the day, the assessment reveals there are no options to revive the company, the responsible parties must look at all alternatives to maximize the return to its creditors.

Remember, when a company cannot pay its debts when due, the fiduciary responsibility shifts from the shareholders to its creditors.  Companies in this situation must act quickly as the value of the company’s assets declines rapidly.

It is also important to reach out to a firm experienced in helping responsible parties assess their situation and who can suggest alternatives for improving the return to its creditors.

If one believes a company you are affiliated with is headed towards the Zombie World, it is extremely important to evaluate options for improvement before its too late.

 

Revitalization Partners specializes in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations. Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.