Financial Poise
Distressed Debt Investing

An Alternative Exit Strategy for Distressed Business Owners

A Case Study on Distressed Debt Investing

Imagine the following situation.

A third-generation, family-owned, metal-bending business was in distress and lacked a proper exit strategy. While sales were strong, the management and facilities had not kept up with market conditions, and the business continued to lose money. The original factory was long since outdated, and half of its space was used for storage on prime real estate. The Mexico operation had been generating all the profits for years, even though it was treated as the corporate stepchild.

The Problem: A Flawed Exit Strategy and Stubborn Leadership

The family leadership was well into its 70s—and tired. The types of decisions that needed to be made caught leadership like a deer in headlights. The bank was trying to avoid a workout, and it was still supportive, but it was approaching the limit of what a long-term relationship can do to help a non-performing business.

The new CEO was a trusted employee with technical skills, and the family patriarch passed the baton to anyone who would take it. The Board did not consider searching for an outsider with the skills and talents required to save the situation.

So, there was a lack of leadership, capital and cash flow, but not a lack of commercial opportunity. The Board had decided it needed to market the company to relieve the family of the financial burden, and to provide an exit strategy for the family executives. They knew the business was not worth much, but they felt as if they had no choice.

At one time, the business was worth between $20 million and $30 million. Currently, there was no value left in the business. It needed to be fixed for the family to regain capital above liquidation value. The real estate was worth more than the business, but the family was not making good decisions. The family was unable to do this themselves and unwilling to bring in help while they owned the business.

The Solution: Distressed Debt Investing and Supplementive Management

Fortunately, I was able to find an alternative. An asset-based lending (ABL) fund I worked with specialized in mature manufacturing businesses. They proposed to buy the bank debt (at a discount) as a distressed debt investment, inject capital to revitalize the factories and supplement management as needed. They had a very strong background in metal-bending businesses, having been through this process several times. They would bring in talent, fix the manufacturing problems, sell the non-productive real estate and force the necessary, tough decisions to improve the value of the business.

The family would not have to sell all of its equity. In addition to a distressed debt investment, the ABL fund would take a minority position in the business. With these actions, they hoped that all parties would exit at a rich valuation in several years. This created an option for the family that did not previously exist, saving hundreds of jobs and redistributing risk and reward more appropriately. While it is too soon to know the final outcome, we are optimistic that the situation will end well for all parties. Sometimes, it is who you know, not what you know, that matters.

[Editor’s Note: Did you know that Financial Poise’s sister website, DailyDAC publishes articles devoted exclusively to teaching its readers about distressed businesses? Experts from leading law, consulting, accounting, investment banking, and other professional service firms offer education about how to handle your businesses should it become financially distressed; how to deal with the insolvency of one of your customers, suppliers, or contract counter-parties, and how to invest in distressed debt and assets. DailyDAC also provides public notice of sales involving overstock inventory, excess equipment, and financially distressed companies and their assets. It features an opportunistic deal database. If you are interested in auctions in bankruptcy cases, receiverships, assignments for the benefit of creditors, and under Article 9 of the Uniform Commercial Code are going to take place, DailyDAC is the place to look! ]

Read more: What is Private Equity? A Brief History

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About Bruce Werner

Bruce Werner is the Managing Director of Kona Advisors LLC, which provides advisory services to owners and investors of private and family-owned companies. With exceptional experience in finance, strategy, M&A, governance, and succession planning, Kona Advisors creates practical solutions to the most challenging corporate problems. Mr. Werner is an experienced Corporate Director, leading businesses through…

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