Consulting Services

BEST Solutions: Business empowerment and strategic turnaround

Debt Elimination

RISE Solutions: Commercial debt settlement & restructuring

Alternative Lenders Assume First Position by Eliminating Subordinate Debt

Article | April 11, 2019

Learn how subordinate debt schedules can be eliminated in a single, streamlined transaction that will scale your deal flow and allow you to offer service and benefits to clients that you couldn’t otherwise.

A person leading a pack of people

In this article, you will learn how a single, streamlined transaction can eliminate business debt and put you in first position to lend. Overleveraged target opportunities can become pristine and debt-free in 45-60 days, so you can lend freely against the entire asset base.

As a result, you can scale your deal flow by evaluating target opportunities differently, with a focus on top-line factors irrespective of the debt schedule.

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. Your target enterprises typically don’t qualify for traditional lending, so a disproportionate number of them come to you on the spectrum of distress, with target assets already encumbered and, therefore, untransactable.

The MCA (Merchant Cash Advance) Problem

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 

Your Target Enterprise is Out of Options—But You Aren’t

When a target enterprise has stacked creditors on a lengthy debt-schedule, it is likely you—the alternative lending professional—are viewed as the last financing option by an owner in distress.

They’ve exhausted the spectrum of conventional and alternative lending vehicles and can no longer capitalize their business. They are on the brink of an unsupportable financial position as a precursor to default and insolvency.

The conundrum is that these businesses often have attractive asset bases and AR, but aren’t transactable.

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. Alternatively, you also do not need to incur the expense and risk of attempting to resolve them through cumbersome, inefficient short sales or negotiated settlements.

In situations like these, there is a solution that not only eliminates the debt schedule and puts you in first position to lend, but also to offers distressed owners a path to preserve the business from insolvency and failure.

That solution is business debt elimination, which results from a streamlined transactional reorganization. It will scale your opportunities, as well as your goodwill and reputation.

Reorganization Creates a Win-Win for all Partiesand an Opportunity for Lenders

So, what is business debt elimination? In short, it is a result and benefit of an alternate means of selling business assets at the point of failure. Unlike a liquidation at auction (which destroys the core value of the business), assets can be strategically liquidated through a private sale into a purchasing entity—thus fully preserving the core value of the company, its continuity of operations and its jobs.

The result is a pristine, unencumbered entity to which you can lend in first position.

“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 the first position secured creditor—in short, the bank. At the point of default, it allows the senior creditor to sell their collateral in a private, out-of-court sale in order to recover maximum value. Through this transaction, all subordinate liens and obligations are removed.

The elimination of subordinate liens is for the senior creditor’s protection 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 provides 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 and operation are 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 short sale is directed toward negotiation with only the first position creditor. It is fast and frictionless because it quickly returns the first position creditor’s appraised asset valuation.

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 completed within 45-60 days, resulting in a pristine entity ready for lending in first position.

Maximum Benefit for All Parties

The Article 9 short sale is so efficient because every party in the transaction is incentivized. While there is necessarily an ownership change, distressed entrepreneurs are afforded a path that avoids bankruptcy while allowing for a successful exit. 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 without the mess of formal liquidation.

Subordinate creditors can write off their bad investments more quickly and take advantage of the tax benefits therein. Additionally, the purchasing entity will often engage the previous owner in a contingent/performance-based compensation package to create a path to resolving 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 in Second Wind 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 

Your Untransactable Deals Become 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 the ongoing concern value, jobs and economic activity that otherwise would have been destroyed through forced liquidation.

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.

Start an Alliance

Contact us about how a strategic alliance can create pristine, transactable situations for your lending model.

    • Your information is confidential and will not be shared with outside parties, see our Privacy Policy. By submitting this form you agree to our Terms of Service.

    Sending Message...

    Message Sent

    A representative will be in touch
    with you shortly.