When Distress Means Opportunity: The Value of Article 9 Re-organizations for Private Equity Investors and the impact to Seller Subordinated Debt.
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. Unless you know how to apply Article 9 of the UCC code.
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 nearly futile short sale attempts can be prohibitive, or alternately they can set a prohibitively high bar on your private valuation, negatively impacting ‘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 know-how 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 type of transaction is facilitated under Article 9 of the UCC, and eliminates 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 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 Uniform Commercial Code protects the interests of 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 the assets will be free of any and all liens and encumbrances post-sale. 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 by result, 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.
Attractive Value. You will enter at the far more attractive cost of the liquidation value of the assets rather than the note.
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 in order to resolve personal guarantees.
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.
Control. 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 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 through the elimination of subordinate debt, you deploy your capital more quickly and more efficiently, greatly accelerating your capital deployment cycle, and by result, increasing ROI.
Leverage. When your acquisition is debt-free prior to or through 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.
Adam Duso is CEO of Second Wind Consultants, one of the fastest growing consultancies in the US. Adam’s areas of expertise include Secured Debt Workout, Unsecured Debt Workout, IRS Debt Negotiations, Value Added Business Consulting, Leveraged Buyouts, and Acquisitions.