Distressed Companies

On the Corporate Renewal Timeline there are two classifications of companies: underperforming and distressed.  Underperforming companies are in early to mid-decline.  Distressed companies are in late decline and / or insolvency.  They are usually pushed into an Informal Creditor Workout  or Crisis Management, e.g., Bankruptcy or Liquidation, because they are unable to pay their bills as they become due.

Informal Creditor Workout.  When an underperforming company waits too long to confront its problems, it becomes distressed.  Lenders and creditors gain leverage over management, and can force management to take actions they don’t want to take, such as pay cash for all goods and services, or sell assets to pay off debts. 

It has been estimated that just 20% of distressed situations can be turned around.  Even if the firm is able to restructure its debt and “work out” a payment plan with its creditors, it may fail the Viability Tests:  there is no core business; it lacks sufficient financial resources to get back to break-even; and it lacks the organizational resources (people, processes and systems) needed to execute the turnaround. 

Even though many such turnaround efforts are attempted, few succeed because the firm's value has already evaporated. 

Another key determinant of whether the situation can be turned around is the relationship between the firm’s enterprise value (present value of the future cash flows) and the mounting claims against that value.  When the claims exceed enterprise value, the firm is insolvent and in crisis management mode.  Before consuming the firm’s remaining cash and assets in a failed turnaround effort, management and its advisors must evaluate whether to sell the assets or to merge with another firm.

Crisis Management.  Companies that are unable to “work out” or restructure their debts are forced into crisis management: 

When a company’s liabilities exceed its assets, or the claims exceed the enterprise value, the options are limited.  It may seek protection from its creditors with a voluntary Chapter 11 bankruptcy filing, or it may find another firm to merge with.  Alternatively, the firm’s creditors may come together and force it into an involuntary bankruptcy filing that may ultimately result in a Chapter 7 liquidation of the assets.