In today's economic environment, distressed companies seek help from "non-traditional" sources of capital.
Frequently, we are approached to assist in
raising equity for companies that have
encountered financial difficulties and
are feeling pressure from concerned lenders.
In today's environment, many firms find
themselves over-leveraged, without adequate
liquidity, and in default of their credit agreements.
A seemingly obvious answer is an infusion
of fresh equity capital from a new investor
to pay down excessive debt and ease liquidity
constraints. In truth, "turnaround" or "specialsituation"
investors are rarely willing to assume
the problems of others and dole out capital to
preserve the investments of existing capital
providers (owners and bankers). They are,
however, willing to participate in the restructuring
of the balance sheet of a distressed company
by supplying liquidity at a time when the
current capital providers will not or cannot.
For serving as the capital provider of last
resort, turnaround investors expect to earn
returns on par with venture capital, which
means that the business or assets will be conservatively
valued going in. As a condition to
becoming involved in a distressed situation,
turnaround investors require recognition of
economic reality on the part of all capital
providers and management. They will insist
that all the current capital suppliers "markto-
market" their positions; this may entail,
subordination, cancellation, or conversion of
debt to equity, and dilution of current shareholders'
equity positions. Moreover, they are
rarely hesitant to insist on control, in order to
protect their investment. This gives them the
authority to make the operating management
changes they deem necessary to restore the
business to financial health.
Special-situation investors can be likened
to financial engineers, rather than business
operators. They seek to invest in turnaround
plans that are predicated on cost reduction,
capital availability, capital investment and, in
some cases, the introduction of new management.
Turnaround situations, where success
relies solely upon revenue growth, technology
development, or the ability to complete subsequent
acquisitions, generally are less attractive.
A well-known turnaround investor tells
us that it is most often part of a financial engineering
play designed to adjust the capital
structure to fit the current circumstances,
provide time to address the factors that caused
the current distressed situation, and align
the interests of management, employees and
capital. Lionel Boissiere of the turnaround
investment fund of Doyle & Boissiere, LLC
(www.DBLLC.com) says that it seeks fundamentally
sound businesses that are burdened
with over-leveraged capital structures, and
cannot otherwise attract capital. The business
must have a history of financial performance
other than for an explainable set of conditions
that can be rectified according to a concrete
turnaround plan. The new capital that DBLLC
invests is usually structured as common equity
or preferred convertible equity, depending on
the situation. Their fund expects to work with
the company to "right the balance sheet" and
demonstrate positive operating performance,
after which it will often exit via a recapitalization
or sale to a buyout fund.
Turnaround investors are short-term partners
who provide, in essence, bridge financing
until the circumstances that caused the
distress are corrected and stability is proven.
The expectation is that once the problem is
corrected, the company will be able to support
a more normal capital structure and will pursue
its natural evolution.