As an asset-based or factoring lender, transactable collateral is your lifeblood. Yet, regardless of how efficient your model is, or how good your reputation and marketing are, deal-flow is inevitably bottlenecked by a simple fact: because your target enterprises typically don’t qualify for traditional lending, a disproportionate number come to you on the spectrum of distress, with target assets already encumbered and therefore untransactable.
“The difficulties often involve how much debt versus receivables (the borrower) has out there. We need to take a first lien position on the accounts receivable, so, therefore, if there is a current lender that has filed a UCC lien, we need to be in first position and thus have enough to pay them off…”
Nancy Kalman, United Capital Funding
In this article, you will learn how the subordinate debt schedule can be eliminated in a single, streamlined transaction that will create a pristine, transactable entity in 45-60 days—putting you in first position to lend against the entire collateral base.
By result, you can scale your deal flow by evaluating target opportunities differently, with a focus on top-line factors irrespective of the debt schedule.
Your Target Enterprise is Out of Options
When a target enterprise has stacked a lengthy debt-schedule, it is likely you—the alternative lending professional—are viewed as the last financing option by an owner in distress.
In these situations, the owner is most likely out of options, whether or not they realize it. They’ve exhausted the spectrum of conventional and alternative lending vehicles and can no longer capitalize their business. They are, simply put, on the brink of an unsupportable position as a precursor to default and insolvency.
The conundrum is that in many of these situations the asset base and AR are attractive, yet untransactable.
In most cases, the alternative lender simply walks away. In other cases, lenders will attempt a complex global settlement of a lengthy debt schedule in order to assume first position—if the long-term opportunity merits this strategy within their model. However, there is no longer a need to walk away from these situations, or to incur the expense and risk of attempting to resolve them through cumbersome, inefficient short sale attempts or negotiated settlements.
The MCA (Merchant Cash Advance) Problem
The now ubiquitous presence of Merchant Cash Advance lenders scales the problem. Beyond competition, this industry represents a highly aggressive form of “lending” in which the lending model is not incentivized by the long-term well being of the business or lending relationship. The probability of ultimate default and insolvency is assumed within the lending model, so as to extract as much as possible, all the way to the bottom, through MCA debt stacking.
For the ABL or Factoring Professional, it is more common than ever to come across opportunities with attractive assets/AR, mired in a lengthy debt schedule comprised entirely of MCA advances.
“Many, many times, debt prevents us from closing a deal because there are not enough receivables to pay off the MCAs.”
Nancy Kalman, United Capital Funding
“Over the years this has become almost a plague against some of these businesses…it’s maybe a couple of times per month where I’ll come across this as a significant problem.”
Chris Lehnes, Live Oak Bank
In situations like this, there is a solution that not only eliminates the debt schedule to put you in first position but also allows you to offer a path to distressed owners to preserve the business from insolvency and failure. This will scale your transactional opportunities, goodwill and reputation.
Reorganization Creates a Win-Win for all Parties
So, what is business debt elimination? In short, it is a result and benefit of an alternate means of liquidating business assets at the point of failure. Instead of liquidating assets at auction (and thereby destroying the core value of the business), assets can be liquidated into a purchasing entity—thus preserving the core value of the company, continuity of operations and jobs.
“In these situations, a reorganization would be of enormous benefit and help, because we’ve absolutely had to turn down deals when we could not take first position on a lien…
We’d be able to get a lot more deals done.”
Nancy Kalman, United Capital Funding
Understanding this process requires familiarity with Article 9 of the Uniform Commercial Code. This provision is designed for the protection of first position secured creditor—in short, the bank. At the point of insolvency or default, it allows the senior creditor to transact (liquidate) their collateral in a private, out-of-court sale in order to recover what they can. Importantly, it also eliminates all subordinate liens and obligations.
The elimination of subordinate liens is to the senior creditor’s benefit because, in order to transact on their collateral, a potential buyer requires assurance that they are receiving those assets free and clear. In short, Article 9 of the UCC creates the means for the first position creditor to sell their collateral efficiently. But unlike in bankruptcy, this collateral does not need to be sold off at auction.
The Article 9 transaction affords the first position creditor the option of liquidating business assets into a new or existing purchasing entity instead. When business assets are liquidated into a purchasing entity, the ongoing concern value is preserved.
“I was really surprised to learn that this process has something in it for everybody—including the second level of lien holders that actually don’t get paid on their liens—but because they’re going to preserve the ongoing business and it will be a new entity probably with better management, they can keep the customer.”
Greg Carpenter, M&A Business Advisor
A Streamlined Path to a Pristine Entity
Unlike traditional short-sales which are a cumbersome center of cost, time and risk, the Article 9 strategic short sale is directed toward negotiation with a single creditor. It is fast and frictionless because it returns the first position creditor’s appraised asset valuation quickly.
After a 10-day notice period to subordinate creditors, business assets transfer free and clear of all UCC filings and encumbrances into the purchasing entity.
Because a purchaser has been lined up for the transaction, operational value and continuity pass into the new entity, unhindered. This process is usually complete within 45-60 days, resulting in a pristine entity ready for lending in first position.
The Article 9 short sale is efficient and frictionless because every party in the transaction is incentivized. While there is necessarily an ownership change, distressed owners can be afforded a path to avoid bankruptcy while also exiting successfully from an otherwise impossible situation. The purchaser enters into an ongoing concern at the attractive cost of liquidated asset valuation. The first position creditor receives maximum return on their collateral. Subordinate creditors can write down their bad investments more quickly and take advantage of the tax benefits thereof. Additionally, the purchasing entity will often engage the previous owner in a contingent/performance-based compensation package to offer a path to resolve personal guarantees, which represents an additional benefit for subordinate creditors.
“Deals don’t happen all the time because there’s too much debt… “I recognized the value immediately. Bringing Second Wind in allows us to bring a business owner out of a really bad situation, and when everybody wins, that’s the best model.”
Troy Tucker, Blue Sky Business Resources/Committee Chair, M&A Source
Turn Untransactable Deals into Great Situations
It’s time to reevaluate your opportunities. Second Wind Consultants has conducted more Article 9 reorganizations than anyone else. Over the past ten years, thousands of businesses have been spared from bankruptcy—preserving ongoing concern value, jobs and economic activity otherwise destroyed through forced liquidations.
Bring Second Wind your untransactable opportunities. There are no fees for the lending professional. In a matter of weeks, we will deliver back a pristine entity ready for lending in first position. Contact Second Wind Consultants today about a strategic alliance that will scale your deal flow and allow you to offer service and benefits to clients that you couldn’t otherwise.