Summary
A previously successful California co-packer, with historic revenue of $20MM annually, became insolvent due to a perfect storm of factors. After a highly-leveraged investment in a second plant, loss of a major contract, and decreased demand during the Covid-19 pandemic, the business was facing imminent liquidation by its senior lender.
With the company in default and now facing several lawsuits, the owner attempted to sell off his second location and sought the aid of private investors. Unable to source recapitalization, he was facing foreclosure and liquidation of the company’s assets, setting up a worst-case scenario for everyone involved: The business would be lost, its employees would lose their jobs, and secured creditors would collect pennies on the dollar through the sale of assets at public auction.
Backstory
The client, a renowned biochemist, opened a contract packaging company to develop and manufacture organic, healthy beverages using proprietary aseptic technologies and flavor systems. From the onset, he acquired a significant amount of debt–initially to purchase equipment and later, to expand operations. Part of the expansion included building out a second location primarily to service a customer who promised to place significant orders.
The customer, to which the second plant was highly leveraged, backed out of the relationship leaving the business unable to meet its debt service on the build-out. To make matters worse, the unforeseeable arrival of COVID led to a drastic decrease in overall demand and orders. The plant suddenly found itself in default with dozens of creditors, many of whom filed suit against the company. The plant’s in-house counsel could not offer a viable solution, so the owner attempted, unsuccessfully, to sell the second location to generate a cash infusion.
The plant continued to borrow from private investors to keep itself afloat, but the situation worsened. By the time the owner contacted Second Wind Consultants (SWC), the first position creditor was preparing to liquidate the plant’s assets.
Second Wind’s Solution
Business default typically creates an adversarial relationship between borrowers and lenders. SWC’s involvement removes that adversity by working with all parties to develop pragmatic and mutually beneficial solutions.
The fundamental concept is simple: if the business can be preserved rather than shut down and liquidated, all parties will benefit.
SWC accomplishes this global benefit through a strategic reorganization, centered around a Uniform Commercial Code (UCC) Article 9 Sale. The Article 9 Sale is a form of asset sale conducted cooperatively between the bank and guarantor. Unlike formal liquidation, this sale of business assets is undertaken while a business is operational, rather than after it has shut down. Assets are sold in their entirety, in operation, into a new legal purchasing entity. Not only does this form of sale spare the bank the time and costs of formal liquidation, but more importantly, it fully preserves the business operation itself, without interruption. The Article 9 asset sale also has the benefit of being a private, non-judicial business transaction that does not publicly signal distress to customers or vendors.
As a result of the Article 9 asset sale, debt is entirely removed from the operation as the business transitions from the insolvent operating entity into the new, unencumbered operating entity. In this way, the business is quickly resolved and relaunched. Returning the operation to viability and profitability means the defaulting borrower can continue to earn from the business and thereby resolve personal guarantees on debts removed–without a bankruptcy. At the same time, secured creditors benefit through recovery that exceeds what would be expected at auction. This is why the Article 9 reorganization is a cooperative process, as it offers a better outcome for all parties.
The Process
The co-packing plant became a client in January of 2021. SWC’s first order of business was to negotiate with the plant’s creditors to buy some time. Starting with the bank, SWC arranged for a settlement of 10 cents on the dollar.
The next step was a negotiation with the first position creditor to prevent them from foreclosing on the plant’s assets, effectively putting them out of business. SWC arranged for the assets to be purchased for $3.8MM by a new entity comprised of three key employees from the original plant. The Article 9 sale was financed through an SWC asset-based lending alliance and closed in the second week of May.
When the original funding partner for the Article 9 sale fell through, SWC pivoted to executing the deal directly with the first-position creditor, and deftly navigated the hefty requirements of their legal team. The landlord of the plant’s second location also caused delays in securing the lease assignment for the new company. The sale closed later than expected, but in enough time to avoid going to public auction.
An additional obstacle came in the form of a private lender threatening an injunction to delay the sale if he wasn’t guaranteed payment out of the new company. SWC was able to satisfy his attorney’s demands without overtaxing the new entity or threatening the status of the Article 9 sale.
The final step was putting in motion an employment agreement between the original owner and the new company, with a portion of the earnings going toward the settlement of his personal guarantees.
Results
With a clear strategy in place, the co-packing plant was able to reorganize into a new entity that stayed fully operational, saved 50 jobs, and avoided the trials of business bankruptcy. In total, nearly $4 MM was removed from the company balance sheet.
The debt-free, cash flow-positive business will allow the previous owner to earn a paycheck and ultimately settle his personal guaranties on the original defaulted loans.
Throughout the process, the company’s distress and subsequent reorganization were shielded from public view. Currently, SWC is helping the new company acquire the most advantageous deal on the sale of their second location. With this infusion of working capital, the new company will be poised for success.