In your experience, do most companies realize they are in distress early on or do they not realize they are in distress until they start defaulting on payments? What are some of the early warning signs that a company might be going into distress? 

The answer is two-fold; management might understand that there is an issue but not the magnitude nor the speed at which distress is overtaking the enterprise. From a broader perspective, management tends to understand trouble is on the horizon, but reality doesn’t set in until a milestone is missed or covenants are in near-term jeopardy. Until a hard and fast marker hits, management, whether the result of optimism or ignorance, may believe it is a short-term problem that can be managed away, and the company will be fine in time.

Some early warning signs would include: cash flow issues, loan covenants approaching limits, operational bottleneck and constraints, and unforeseen and unexpected financial downturn. The earliest signs of deeper underlying distress may be making payments a few days late and the need to move funds to cover expenditures or trying to manage expenses on the “float”. 

When a company is in distress, they have a lot of options to consider (e.g. merger, Chapter 11/7, acquisition, remaining a standalone entity). How involved do you typically get in helping companies evaluate their options?

First, is to determine a desired and feasible outcome: Is it continued operations, a sale, a merger, or simply an exit via liquidation. Once that decision is made the proper avenue to affect that decision can be determined.

We can assist with both of these steps. Developing an understanding of why the distress occurred, was it a hiccup on the way or a fundamental change in the way the company does business, or a systemic change in the marketplace can help inform the outcome determination. The evaluation of options can quicky follow and is typically what is the most efficient and cost-effective solution that provides the required protection to the client.

What is the most complex aspect of valuing distressed businesses and why?

There is no one true answer to be had, each valuation is specific and has its own considerations. For example, whether the distress is transitory or permanent; whether the underlying cause is financial, operational, or managerial; and whether the required knowledge and know-how is available to affect a turnaround. Other considerations include why the company is being valued and how these circumstances will be accounted for in the valuation itself. These facets need to be considered and evaluated in concert with the determination of value. 

Further, depending upon the facts and circumstances, there may be competing determinations of value to contend with. Thus, thoroughly understanding the subject interest, the intended purpose of the valuation, and the motivations of other parties in interest are key in formulating a reasonable and reliable valuation conclusion.