Though there is no official definition of “special situations,” the phrase is often related to a type of security that has lost value due to difficult circumstances, but which investors feel has the potential to rise in value. This is usually associated with a specific catalyst, such as a spinoff, bankruptcy, activism or unusual complexity.
But in the private company world, the definition of special situation is a bit broader. While the above definition still works, owners and families of private companies have more issues, since their securities are typically illiquid. Private and family businesses have issues that are due to their ownership, but the problems are not within the business itself. These are vexing, because often no one person is clearly responsible to resolve the problem. Further, the people who suffer the consequences often are not equipped, intellectually or financially, to address the issues properly.
Here is a recent example I have worked on.
A 75 year-old family business was sold in 2003. For most of its years, the business was healthy. However, over the decades, the business became burdened with debt used to buyout family members. This worked well while markets were strong. But as with most manufacturing businesses, the sourcing moved to China, and the core business faltered. Eventually, the owners handed the keys to a large strategic buyer, just to avoid bankruptcy.
Fast forward to 2020, and the patriarchs reach out to start a conversation.
There are still product liability claims outstanding from products sold while they owned the business, which, they fear, could pierce through the corporate veil and invade the family’s assets. This was really about grandparents trying to protect their grandchildren’s assets. The grandparents couldn’t sleep at night knowing there was an unmitigated risk that could hurt the grandchildren.
To solve this problem, we assembled a team of lawyers, accountants and other experts to assess the risk and recommend action to the family. This meant starting with the transaction documents, understanding the representations and warranties, assessing which entities were in good standing, and how all of this tied back to the ownership structure. Then, we needed to look at the various estate plans and see how culpabilities might flow. We also looked at the frequency and severity of claims, claims history, plaintiff bar activity, and class action eligibility.
The goal was to quantify the risk, and determine what, if anything, should be done. The product liability risks were no longer insurable, and the family would not have been able to afford insurance if it were available anyway. The most likely action was stepping up the asset protection features of the various estate plans.
A few other nuances were that (1) several of the grandparents had not spoken to each other since the business was sold, (2) there had been a death in the generation, (3) there was severely limited access to company records, (4) several of the grandchildren only wanted to work with female advisors to promote diversity, and (5) the family was spread out across the entire US.
Managing this situation is beyond the typical scope of an attorney, accountant or wealth manager. While many in those professions can and do address these types of problems, it is not their core service offering, and they can be conflicted or limited in the solutions they can deliver. They may also have regulatory and/or fiduciary limitations.
The lesson is that “special situation” means defining and managing an overall process to address an unusual problem. In this case, the key needs included: defining the scope of the issue,; creating a process to address it; qualifying and coordinating experts; and then explaining the complex subjects to elderly, and in various cases, unsophisticated clients, so they could competently and comfortably make judgments on life-altering matters.
[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Key & Common Negotiation Provisions – Part 1 and Estate Planning and Asset Protection – 101.]
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…