Q: Do companies typically recognize distress early or only after defaulting on payments? What are the early warning signs?

Brett Burgan: 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. Many times, the financials can be deceiving as the company is generating earnings, but cash flow is eroding due to debt payments or working capital pressure. 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”. 

Q: How involved are you in helping distressed companies evaluate options such as a merger, Chapter 11/7, acquisition, or remaining standalone? 

Brett Burgan: 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.

Q: What are the key differences in valuing a distressed business as opposed to a more traditional valuation? 

Brett Burgan: While the valuation methodologies are similar in both scenarios, there are key differences that have to be accounted for when valuing a distressed business. For instance, a discounted cash flow analysis is typically utilized, but for a distressed business, an analyst needs to probability-weight the restructuring outcomes and utilize a higher discount rate. Similarly, market-based approaches can be utilized, but special considerations must be given when selecting comparable companies or precedent transactions, as distressed companies often trade at substantial discounts to normal industry valuations. In certain instances, the assets of the business may be worth more than the value of the business as a going concern. When that's the case, it becomes necessary to assess the value of the assets under both an orderly liquidation and a forced liquidation.  

In all methods, though, it's important to factor in the bankruptcy and restructuring costs, i.e. legal fees, financial advisors, court costs, etc., as those will impact overall value.  

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

Brett Burgan: 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.