Restructuring / Distressed M&A 1 Flashcards

1
Q

How much do you know about what you actually do in Restructuring?

A

Restructuring bankers advise distressed companies—those facing bankruptcy, in the midst of bankruptcy, or looking to avoid bankruptcy. They help these companies modify their capital structures to either emerge from or avoid bankruptcy. This process can involve financial restructuring, such as renegotiating debt or changing the company’s capital structure, and operational restructuring, which focuses on improving business operations. They negotiate with creditors, assist with the sale of assets or the company itself, and if bankruptcy is inevitable, they guide the company through bankruptcy proceedings, including Chapter 11 (reorganization) or Chapter 7 (liquidation). They also develop strategies for the company to successfully emerge from bankruptcy.

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2
Q

What are the 2 different “sides” of a Restructuring deal? Do you know which one we usually advise?

A

The two main sides in a restructuring deal are the debtor’s side and the creditor’s side. On one side, you’re advising the company (debtor) that is trying to sell or restructure its obligations. On the other side, you’re advising the creditors—such as banks, mortgage lenders, or bondholders—who are seeking to recover as much of their investment as possible from the company.

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3
Q

Why are you interested in Restructuring besides the fact that it’s a “hot” area currently?

A

Restructuring is a very technical and highly specialized area, which makes it more interesting and you more valuable as an employee. You also get to see both the good side and the bad side of a company, which gives you broader exposure compared to M&A.

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4
Q

How are you going to use your experience in Restructuring for your future career goals?

A

I would use my experience in restructuring to better assist clients in M&A deals. Restructuring would equip me with superior technical skills that are critical for M&A, allowing me to negotiate terms more effectively and evaluate investment opportunities with greater precision. Additionally, the insights gained from understanding how companies fail would enhance my ability to assess the risks of potential transactions.

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5
Q

How would a distressed company select its Restructuring bankers?

A

Restructuring and distressed M&A deals require more specialized knowledge and relationships than the typical IPO process. There are only a few banks that offer restructuring services, and a distressed company would typically select them based on their experience with similar deals in the industry and their relationships with other key parties involved in the process. Restructuring usually involves more stakeholders than a typical M&A deal—such as lawyers, shareholders, debt investors, suppliers, directors, management, and crisis managers—making these relationships especially important.

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6
Q

Why would a company go bankrupt in the first place?

A

Some of the most common reasons are:
1. The company is unable to meet its debt obligations or interest payments
2. They were forced into bankruptcy by creditors who accelerated their debt payments
3. An acquisition went poorly or a company has just written down the value of its assets steeply and needs extra capital to meet its minimum capital obligations
4. There is a liquidity crunch and the company can’t afford to pay its vendors or suppliers

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7
Q

What options are available to a distressed company that can’t meet debt obligations?

A
  1. They can refinance and raise capital by obtaining fresh debt and equity
  2. They can sell the company, either as a whole or in pieces as an asset sale
  3. They can restructure their financial obligations to lower interest payments and debt payments, or issue debt with PIK interest to reduce the cash interest expense
  4. They can also file for bankruptcy and use that opportunity to obtain additional financing, restructure their obligations, and free themselves of onerous contracts
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8
Q

What are the advantages and disadvantages of each option?

A
  1. Refinancing
    a. Advantages - Refinancing would provide immediate liquidity to the company. It is the least destructive and would help revive confidence
    b. Disadvantages - However, it would be difficult to find investors willing to provide capital, and higher interest rates and dilutive terms would be imposed. They may also require collateral or guarantees, which would put other assets at risk
  2. Sale
    a. Advantages - A sale would give shareholders some value while generating cash for creditors
    b. Disadvantages - May result in a fire sale. The company would be unlikely to obtain a good valuation and sell for a fraction of its true worth
  3. Restructuring
    a. Advantages - Could resolve problems quickly without third-party involvement
    b. Disadvantages - Could also be a time-consuming process as management and lenders don’t usually see eye-to-eye
  4. Bankruptcy
    a. Advantages - Could be the best way to negotiate with lenders, reduce obligations, and get additional financing
    b. Disadvantages - It would have a negative impact on the company’s reputation and customer confidence. There would most likely be significant business disruptions and equity investors would most likely lose all their money
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9
Q

From the perspective of the creditors, what different strategies do they have available to recover their capital in a distressed situation?

A

The creditor has quite a few options at their disposal:
1. They can undergo debt restructuring - modify the terms of the debt to make repayment easier
2. They can provide additional equity to help the company revitalize itself
3. They can pursue conditional financing - only agree to invest if the company agrees to certain terms and covenants
4. They can force the company into a sale
5. They can seize collateral and force the company into bankruptcy

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10
Q

How are Restructuring deals different from other types of transactions?

A

Restructuring deals are more complex than standard transactions, involving multiple parties, requiring more specialized technical skills, and having to adhere to the Bankruptcy Code. Unlike typical M&A deals, which generally involve negotiations between two parties, restructuring deals involve not only creditors negotiating with debtors but also different creditors negotiating with each other.

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11
Q

What’s the difference between Chapter 7 and Chapter 11 bankruptcy?

A

Chapter 7 bankruptcy, also known as “liquidation bankruptcy,” is used when a company is unable to reorganize and must instead sell off its assets to pay off creditors. A trustee oversees this process to ensure it is conducted according to the plan. In contrast, Chapter 11 bankruptcy is focused on “reorganization.” Under Chapter 11, the company continues to operate while restructuring its debt. This involves renegotiating with creditors to lower interest payments and reduce the overall debt repayments.

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12
Q

What is debtor-in-possession (DIP) financing and how is it used with distressed companies?

A

DIP financing is a type of funding provided to a company undergoing Chapter 11 bankruptcy to help cover its operational expenses while it restructures its debt. The debt acquired through DIP financing has priority over the company’s existing debt, meaning it is repaid before other creditors. This priority is essential for attracting lenders, as it reduces their risk in financing a distressed company. DIP financing is crucial for ensuring that the company can continue its operations and work towards a successful reorganization.

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13
Q

How would you adjust the 3 financial statements for a distressed company when you’re doing valuation or modeling work?

A

The most common adjustments you’d make are:
1. Adjust Cost of Goods Sold for higher vendor costs due to a lack of trust from suppliers
2. Add back non-recurring legal / other professional fees associated with the restructuring and/or distressed sale process
3. Add back excess lease expenses (again due to lack of trust) to Operating Income as well as excess salaries (often done so private company owners can save on taxes)
4. Working Capital needs to be adjusted for receivables unlikely to turn into cash, overvalued/insufficient inventory and insufficient payables
5. Adjust CapEx, as it is often distorted in distressed companies. If CapEx is too high, it may contribute to the company’s financial troubles, while if it is too low, it might be artificially reduced to conserve cash

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14
Q

Would those adjustments differ for public companies vs. private companies?

A

Most of the adjustments would apply to both private and public companies. The point about excess salaries however, would not hold true. It is generally much more difficult for public companies to manipulate compensation in the same way as private companies, making it less likely for there to be abnormal salaries.

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15
Q

If the market value of a distressed company’s debt is greater than the company’s assets, what happens to its equity?

A

The shareholders’ equity goes negative, but the equity market cap would remain positive, as it can never be negative.

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16
Q

In a bankruptcy, what is the order of claims on a company’s assets?

A

The order is as follows
1.New debtor-in-position (DIP) lenders
2. Secured creditors (revolvers and “bank debt”)
3. Unsecured creditors (bondholders and suppliers)
4. Subordinated debt investors (PIK noteholders and high-yield/junk bondholders)
5. Mezzanine investors
6. Shareholders

17
Q

How do you measure the cost of debt for a company if it is too distressed to issue additional debt (i.e. investors won’t buy any debt from them)?

A

You could look at the yields of bonds from companies in similar financial situations or industries, or you could analyze the spreads of credit default swaps (CDS) for similar companies. Additionally, if the distressed company’s existing debt is sufficiently liquid and trading, you could use its current yield as a baseline.

18
Q

How would valuation change for a distressed company?

A
  1. Most of the time, you would use the same methodologies, but you would look at the lower range of the multiples and make all the necessary accounting adjustments.
  2. You would also use lower projections for the DCF and any other method requiring projections, since you’re working under the assumption that a turnaround period is needed.
  3. You might pay extra attention to revenue multiples if the company’s EBIT/EBITDA/EPS are in the negative.
  4. You would also consider a liquidation valuation, assuming that the company’s assets will be sold off to pay its debt.
  5. In some cases, you would look at valuations on an assets-only basis and a liabilities-assumed basis. This distinction exists because distressed companies require adjustments to their liabilities.
19
Q

How would a DCF analysis be different in a distressed scenario?

A
  1. More value would be given to the terminal value, as the analysis assumes several years of negative or minimal cash flow while the company undergoes a turnaround.
  2. Given the uncertainty surrounding future cash flows and financial performance, it would be crucial to perform a sensitivity analysis. Create a sensitivity table exploring different scenarios and their impact on valuation, considering earnings projections in distressed situations are highly uncertain.
  3. You would also add a premium to the Weighted Average Cost of Capital (WACC) to account for the higher risk associated with operating under distress.
20
Q

Let’s say a distressed company approaches you and wants to hire your bank to sell it in a distressed sale – how would the M&A process be different than it would for a healthy company?

A
  1. Timing is often quick. The process is expedited given the urgency to sell the company before it potentially goes bankrupt.
  2. In some cases, you’ll even produce fewer marketing materials (executive summaries, management presentations, etc.) to accelerate the process.
  3. Most of the time it’s the creditors who initiate the sale process rather than the company itself.
  4. Unlike most M&A deals, distressed deals can’t necessarily “fail”. They always result in a sale, bankruptcy, or restructuring.