In this article, you will learn how a simple, streamlined transaction can extract core business value from a distressed entity efficiently and with certainty. This know-how will change the way you assess potential deals and allow 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.
As a private equity investor group, subordinate debt is the single greatest challenge to the efficiency of any model—whether that model involves investing in equity, debt or assets. Add business distress to that sub-debt complexity and executing a purchase/exit can become difficult and time-consuming at best. That is unless you know how to apply Article 9 of the Uniform Commercial Code (UCC).
Simply put, 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 often futile short sale attempts can be prohibitive. Alternately they can set a prohibitively high bar on your private valuation, negatively impacting ‘viable’ deal flow.
However, a streamlined reorganization prior to or through your acquisition (facilitated under Article 9 of the UCC) will eliminate all subordinate debt, while preserving the full continuity and value of business operations—delivering a pristine, debt-free enterprise within 45-60 days. For purchasers seeking add-ons, ongoing concern value becomes available at liquidated asset cost.
For the private equity professional, this is a game changer.
By eliminating subordinate creditors pre-acquisition, private equity investors can avoid complex cramdowns or nearly impossible short sales while also completely sidestepping the time, risk and costs associated with walking a target through Chapter 11.
The strategic use of Article 9 is centered around a controlled 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 Uniform Commercial Code protects the interests of first position secured creditors by allowing them to transact on a business’s asset base to their benefit, free and clear of liens and encumbrances to prospective purchasers. What every PE professional should also know, 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, jobs and full continuity.
The strategic Article 9 sale not only returns maximum value to secured creditors (rendering the transaction frictionless, as it is based on their agreed-upon third-party asset valuation) but 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 benefits are tremendous.
Win #1: Attractive Cost
You will enter at the far more attractive cost of the liquidation value of the assets rather than the note.
Win #2: Path to Exit
You will scale your successful LOI deal-flow by incentivizing sellers with a path to a successful exit when they would otherwise be left facing a string of personal guarantees and bankruptcy and therefore, little incentive to close. How? The delta between the liquidated asset cost and the note can be strategically allocated back to your target seller to resolve personal guarantees.
Win #3: Lower Cost
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.
Win #4: Control
When your strategy involves Chapter 11 or 363 sales, 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.
Win #5: Time is Money
When your acquisition posture is strengthened through the elimination of subordinate debt, you deploy capital more quickly and more efficiently, significantly increasing ROI.
Win #6: Leverage
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 conclusion, the Article 9 strategic short sale is simply 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, thereby transforming distress into opportunity.
For more than a decade, Second Wind Consultants has conducted thousands of Article 9 reorganizations in the distressed space. Find out how a strategic Alliance with Second Wind can benefit your model.