As a private equity investor operating in the distressed space, subordinate debt is the single greatest challenge to the efficiency of any model—whether that model involves investing in equity, debt or assets.
Regardless of your group’s private equity strategy, subordinate creditors create obstacles to closing, they pose risk, and they drain time and money—negatively impacting ROI. Moreover, when a distressed situation involves a complex subordinate debt schedule, the prospect of nearly futile short sale attempts can be prohibitive or can set a prohibitively high bar on your private valuation. In either case, circumstances like these limit your “viable” deal flow.
In this article, you will learn how a simple, streamlined transaction can extract core business value from a distressed situation efficiently and with certainty. This will change the way you assess potential deals, allowing you to focus on value, regardless of the debt schedule. Alternately, the result of this transaction is a stream of pristine add-ons which can be acquired at liquidated asset valuation.
This transaction is facilitated under Article 9 of the Uniform Commercial Code. Article 9 eliminates all subordinate debt while preserving the full continuity and value of business operations, and delivers a pristine, debt-free enterprise within 45-60 days. For purchasers seeking add-ons, ongoing concerns are available at liquidated asset valuation.
For the private equity professional, this is a game changer.
By eliminating subordinate creditors pre-acquisition, private equity investors can eliminate any need for complex cramdowns or nearly impossible short sales, while also completely avoiding the time, risk and costs associated with walking a target through Chapter 11.
The strategic use of Article 9 is centered around a controlled, strategic short sale that is fast and frictionless because it requires the consent of only a single creditor.
Incentives for All Parties in the Transaction
Most know that Article 9 of the UCC protects the interests of the first position secured creditors by allowing them to transact on a business’ asset base to their benefit—with the assurance to the purchaser of those assets that they will be free of all liens and encumbrances post-sale. What every PE professional should also know, however, is that the assets liquidated via a private Article 9 sale can be sold into a new purchasing entity, preserving the ongoing concern value, its operations and jobs.
The Article 9 sale not only streamlines the process of returning maximum value to secured creditors, as it is based on third-party asset valuation, but it also divorces all subordinate creditors from the value of operations. There is simply no more rational or efficient means of extracting core business value in the distressed space.
For your private equity investment strategy, the value-adds are tremendous.
You will enter at the far more attractive cost of the liquidation value of the assets rather than the note.
You will scale your LOI deal flow by incentivizing sellers with a path to a successful exit. Otherwise, they would be left facing a string of personal guaranties and bankruptcy and, therefore, have little incentive to close. How does this work? The delta between the liquidated asset cost and the note can be strategically allocated back to your target seller to resolve personal guaranties.
Because your upfront costs are far lower, and the balance of seller compensation is performance-based, your portfolio will benefit from reduced exposure to those acquisitions that fail or underperform.
When your strategy involves Chapter 11 and a 363 sale, you know how little control you have over the process. It’s lengthy, costly and comes with the risk of being outbid after months of work. Now you can achieve the same positive result in weeks—with full control—through the application of the Article 9 short sale.
Time is money. When your acquisition posture is strengthened by the elimination of subordinate debt, you accelerate your capital deployment cycle and as a result, increase ROI.
When your acquisition is debt-free prior to or through the transaction, the entire asset base is available for you to scale your leveraged buyout model.
In short, the Article 9 strategic short sale is the most efficient means of extracting and transferring business value in distressed situations. For the private equity professional, this means lowering the cost of entry, minimizing exposure to failed acquisitions, creating exit incentives for sellers, and increasing portfolio ROI.
For more than a decade, Second Wind Consultants has conducted thousands of Article 9 reorganizations in the distressed space. Find out how a no-cost strategic alliance with Second Wind can improve and streamline your acquisition posture in any distressed situation or offer you potential add-ons at the attractive cost of liquidated asset value.