You and Greece and Goldman Sachs

So there I was, sitting on a cross-country flight, reading the most recent of several articles published in the past few weeks about the fragile state of Greece’s economy and the involvement, at key points, of Goldman Sachs (seemingly this era’s manifestation of the Wizard of Oz -- the manipulative figure behind the curtain of every economic issue). It suddenly struck me that, in at least two critical aspects, the story of Greece was illustrative of the restaurant bankruptcy exploration in which we’re presently engaged.

For starters, remember that financial bankruptcy (steering away from the intellectual, emotional, or moral varieties for purposes of this column) is essentially a recognition that a company, partnership, or other legal entity (the “Debtor”) cannot meet its financial obligations. [I know there’s a more precise legal definition, but this one will serve for our discussion.] Bankruptcy does not mean the entity has no value; rather, it means that -- as currently configured -- the entity’s obligations exceed its current realizable value. The U.S. bankruptcy process provides a “protected” period of time, during which the entity’s owners, management, creditors, key stakeholders, and Seasoned Counsel (see prior column) on all sides answer the following questions:
1) is the Debtor worth more as a functioning business entity or as a collection of disposable assets?
2) is the Debtor worth more as a single functioning business, or might various functioning pieces be worth more if separated?
3) in assessing this value, what is the likely future of the single business or multiple businesses? Is it worthwhile (for the creditors) to either defer a portion of their claim for some extended period, or to convert some or all that claim to an ownership position, in the hope of a better eventual return?

These questions, and the ways they’re answered, form the framework of the process we’ll be discussing more as we delve into bankruptcy. Meanwhile, it’s worth talking a bit more about how entities reach bankruptcy, and that brings us back to Greece. We’re not going to solve Greece’s issues here -- that might take another page or two -- but perhaps we can explore some of the causes, which are not too far removed from the causes of many restaurant bankruptcies. As I mentioned, its situation is instructive in a couple of ways.

First, Greece apparently was successful in shifting substantial current and future obligations off its balance sheet through derivatives, currency trades, and similar instruments, in many cases actually receiving substantial cash payments at the time of the transaction. (Yes, some of these instruments were designed by Goldman Sachs, and some by other investment banks.) Instruments like these are used every day by businesses and governments. Used properly, they can be valuable financing tools, but they require an acknowledgement that “nothing good comes without a cost”; in the past decade, many restaurant acquisitions were financed by sale/lease transactions (selling the company’s real estate, then entering into long-term leases in order to continue operating units). So long as the lease’s ongoing costs were appropriately considered, and the (now smaller) cash flows after rent payments were not overlevered, the company could operate successfully -- but many operators and investors incurred not only substantial lease expense but substantial debt as well, robbing them of any flexibility just before the economy soured.

Second, Greece apparently “sold” its right to future revenues -- airport fees and lottery concessions, among other income streams -- in return for immediate cash. Many restaurants (especially younger, growing concepts) have entered into similar arrangements, selling either a certain number of meals or a proportion of future revenues in exchange for immediate cash. Once again, there’s nothing inherently wrong with such transactions, but they tend to increase future risk, because they remove some portion of future revenues without reducing future costs; as a consequence, they must be thoroughly analyzed lest they inflict long-term damage (or even disaster) in exchange for short-term relief.

In either of the above cases -- either by increasing the demands on future cash flows, or decreasing the availability of future cash flows -- Greece, and restaurant operators, set themselves a dangerous course. When the world turns sour, and the income diminishes, sometimes the outcome is the informal definition I provided earlier: the entity’s obligations exceed its current realizable value, and bankruptcy is the most likely outcome.