Why Liquidity Matters; or, Cash Is King

We’ve been discussing bankruptcy in recent columns -- the mechanics, the players, the benefits, and so forth. Here is a story, with identities disguised, which conveys the importance of cash -- for flexibility in executing a business plan, avoiding bankruptcy, or making one’s way through bankruptcy relatively smoothly. Remember the comment I noted several weeks ago: “It’s expensive to go bankrupt”, from Allan Hickok. Keep it in mind as I spin this tale.

Company A, with annual sales over $100MM, was purchased several years ago by a private equity fund. While the company has a long, proud history, it has also had some management and operational issues in recent years -- even before the economy tumbled -- and the investor has not seen the performance it expected. Here’s a snapshot of the recent events:

Two years ago, all the liquidity of the company was drained by fees paid to lawyers to represent the company in a fraud investigation.

The investors committed to lend another $3MM (to come in below the lenders). During the three months of lender and investor negotiations (for a $3MM investment), the investor lost the support of its limited partners for the additional funding. (Even funds have problems sometimes.)

Because the investor was unable to fund the $3MM, Company A was not able to make all its scheduled debt payments last year.

Because of the debt payment defaults, the lenders pressed to take over majority ownership. The investor and lenders entered a lengthy dispute over the payment default and the investor’s relinquishing its governance role.

Finally, the lenders and sponsors agreed to the equity split, resulting in the lenders in control. Upon taking possession, the lenders launched a due diligence engagement with an outside crisis management team.

Meanwhile, there was a company to run. Company A’s management had tried to drive the business forward, but key forward-looking strategies and tactics could not be as robust as they should have been, given the significant distractions and lack of available resources. Marketing and menu support were curtailed, resulting in a precipitous drop of guests -- compounded by the past year's consumer issues.

Setting aside losses due to the initial fraud, it’s estimated that this company has spent almost a year's cash flow in fees to (1) lenders, (2) attorneys (several), and (3) outside advisors (including the last -- the crisis management team). Because of these amounts, it’s been permanently weakened. The dollars were not being used to strengthen the company, nor to preserve its liquidity. The investor and lenders both took actions which were intended to preserve their own positions at the expense of the company’s well-being. As a consequence, now that the company has filed for protection, it has a less robust future than it would have had decisions been made differently earlier in the process.

Conclusions:

It’s never too early to think about liquidity.
It’s also never too early to plan for unpleasant outcomes.
Don’t presume that time will cure a short-term catastrophic event -- in this case, the initial fraud. That began this downhill slide, and -- for too long -- all parties assumed time would solve, rather than exacerbate the situation. It’s never too early to conserve cash and insure sources of liquidity.
Talk regularly to counsel and advisors, and evaluate options at each conversation.
And, summing these up, don’t wait for a cash crisis to learn how to manage a cash crisis. Get educated early, from your board, advisors, coaches.

Thanks to the management of Company A for baring their soul to me so I could describe this case.

Tags: bankruptcy, financing, liquidity, reorganization

0 members like this