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Spark's Debt Workout Approach

Spark! Informal Debt Workouts - Scope

Let's assume you have managed to follow your own good instincts and have:

  • Thought carefully on how to make sure the enabling conditions are appreciated by all stakeholders.
  • Obtained in principle agreement on good-faith support of the 9 principles

The Remediation part of the workout needs an initial analysis which should :

  • Assess the firm's Strategic position and any Company Restructuring alternatives
  • Review Operational restructuring improvements and Value Chain rationalization
  • Identify Self-funding efficiency and waste removal opportunities
  • Identify Financial Restructure options
  • and position all Debt Refinancing options

Make the most of the Opportunity.

Certainly, attempting to do too much is a potent recipe for disaster, but a well-thought out triage approach considering more than just Debt Refinancing is essential. Debt Refinancing will not address the underlying reasons why the business is in trouble, which usually are a combinations of operational issues where inefficiencies have destroyed value, derived from a poorly thought out strategy which has been badly executed. You have to work through the symptoms and find the root causes.

Workout Plan - Scope Considerations
Scoping Consideration Purpose
Business Stabilization and Austerity Measures

This should be implemented before the creditor collective of your debt workout grant any kind of grace – take this seriously, big changes require lots of little changes, but most importantly visible and tangible successes upfront, no matter how small but which are quick to materialise. The psychology of your business is important, and building motivation, creating momentum through initial quick wins will energise your staff, and dispel thoughts of people leaving. (Your talent is mobile and the first to leave! Have a plan to retain them) Old habits die hard, and people do not like to give up comforts and those privileges attached to position can be especially hard to remove, even though they are practically the easiest to accomplish. Visible privilege for senior staff in these instances of business crisis, can be very demoralizing for the rest of the business. The business leadership must show commitment to and care for the well-being of their people (great military commanders never eat before their troops have been well-fed!!).

The nature of an austerity programme is that you will learn as you go, it will require prioritizing of actions and areas of focus periodically, and will require constant monitoring. Although you might not be legally required to share data with creditors, consider doing so as you start to achieve results.

If the measures have been implemented, and insufficient benefit is being realised then more extreme/innovative options are available – (my own experience in France of moving the entire business to a 4 day week, with the proportional cut in wages, is an example of this)

Some of your austerity measures are not sustainable in the long run, such as training budget cuts, but others should remain. Others can be re-introduced but on the basis of merit

Strategic Review

This is needed to provide answers to questions on medium term viability. Certainly Trade and Supply Chain creditors will want to know (and have an opinion) on the viability of a business partner from whom they derive profits. Some businesses operate in markets that are distorted (ie strategic industries supported by the government), and some which are true commodities (ie mining which is a price taker with no control), this is a vital consideration in assessing the avenue of appealing to government and assessing company restructuring through mergers.

Creditors providing concessions to a debtor owe some rationale to why they are investing time in the process and must be able to provide the rationale on their decisions, try and make your creditor's lives a little easier if you can.

In terms of developing a value proposition to third parties willing to buy debt or convert debt to equity, this is an important piece of work that does not take too much time, and which will allow you to think of a value proposition for potential suitors

Lastly, on assessing the competence of the debtor’s management or leadership (which is always a conversation that transpires at some stage or another), this artifact will be a good input. An engaged leadership team should be able to produce a coherent and convincing view quickly.

Financial Restructuring

If the debtor is willing to convert debt to equity, then the information needed to do this must be provided. They will attach a value to their equity, which is normally over-valued or done with assumptions that need to be stated in such a manner as creditors can assess them. The valuation will also change based on the point in time in which it is done. T=0 and T+3 months and T+12 months will have different valuations and a discounted cash flow should be used. Industry multiples should be treated with the contempt they deserve.

They must provide a view on debt-subordination and preference vs. ordinary shares as well. You don’t want any surprises later in the process.

Although a creditor’s prerogative, the debtor would be wise to investigate alternative creditors, with different risk appetites and investment time horizons who might be considered as potential new creditors. Much more can be done to access a lot of money seeking viable opportunities.This is not a common solution to dealing with banking creditors in SA, but is very common in other parts of the world.

The debtor should consider estimating the potential costs of bankruptcy, which will include legal and insolvency asset disposal costs.

Debt Refinancing

A proposal must be made in terms of different debt structures, with a set of options between preferred combinations of extension and composition. This should be assessed against the potential benefits of the business rehabilitation plan and its timeline. Debtors overlook the impact of a creditor’s WACC and how this will impact the NPV, so a credible 3rd party needs to review this. This should be handed over to the Creditor collective’s steering committee for finalization as soon as possible

Creditors, especially banks, should consider new or updated loan instruments that can replace the existing loan, especially if they have had change in their own costs of capital, where margins on the loan have improved, and where neither benefit was passed on or shared with the debtor.

In so far as the debtors own role as a creditor is concerned, they should consider the option of factoring or debtor finance which is an independent service run within any of the commercial banks. They are all similar versions of each other, and can be of benefit when managing the AR line on the balance sheet and for accessing working capital quickly (at a cost of course!). This might also make co-operation by the bank more likely

A word on banks - you might hope that a bank would have a "single view of customer", meaning that there is a consolidated overall view of all your products and services, from transactional banking, lending, insurance, investments etc, but this is not the case, despite all that has been said and planned (but one or two are getting there!). The result is that sometimes concessions will be made to retain all the valued business, but sometimes this avenue of negotiation is useless, as the businesses share a brand and a shareholder and have little else in common!

Operational Restructuring

Firstly, this is needed to assess leakage/waste/inefficiency for the work already started in the austerity programme, so the value chain is a key starting point. Each part of the value chain should document the accountable business leadership, and the functional areas within the value chain, with head-count and budget.

You will use this simple view to assess key management accounting benchmarks, such as the ratio of client facing or revenue generating staff to, middle office support and back office functions.

Consideration must be made as to what a core function is so that thinking can start on the disposal of assets and the use of outsourcing of any function to those who specialize in it (a call centre is a classic example, and if Financial Services businesses can outsource sales – which is what a broker is, then why can’t other functions be outsourced, get done better and for less cost, with greater control)

Each step of the value chain should also list the business processes involved and the hand-over points to other parts of the business. This will be critical in some of the self-funded tactics we will introduce to you (which without exception have always added disproportional benefit for the effort involved in our experience)

Answers to product, distribution channels, footprint, potential for asset disposal, org structure and outsourcing etc must be answered here.

Company Restructuring

This is a piece of work which depends on all the other pieces of work being done. A business that is failing, often has only parts of it that are dysfunctional and eroding value. It is not uncommon to find parts of a business that are world class and which in and of themselves are very valuable in a business that is financial distressed. Often this scenario arises from a laudable leadership decision to "diversify" their business and to enter new markets or seize new business opportunities. Unfortunately, sometimes these fail and the business must return to what its core functions are and what its original success was derived from.

In those instances where an industry requires scale to compete or where very specialised skills are required, company restructuring will allow the reallocation of resources and capability. The original entity and its brand might disappear but jobs will be saved and customers not let down, whilst at the same minimizing your creditor's loses.

Tactical Self-funding Initiatives

This is essential, as no creditor wishes to expose themselves to more risk by "throwing good money after bad", in this instance a Supply-chain creditor and a banking creditor think and act very differently, and not always rationally!

Remedial plans often have an over-emphasis on revenue generation primarily, as the removal of waste or inefficiency is often seen as a tacit admission of poor management and parts of the business where waste or inefficiency is hidden, yet known, are loath to admit the failing. Yet 100% of cost or waste removal flows through to the bottom line, whilst with revenue plans, far less impact is felt on the business (businesses with marginal costs of additional production rarely are in financial distress)

Very importantly, creditors require certainty and you must earn their confidence (as the COO of a major bank I have personally been on the receiving end of these "plans"), and dealing with waste and inefficiency deals with actual costs, whilst revenue plans are always projections and far less certain. Certainty combined with remaining self-funding makes dealing with creditors far easier.

A Debt workout with a difference

Our approach is to equip you with all the insights from a business diagnosis, which is summarized in an action plan with clear steps on how to capture the savings and benefits you need to meet your debt repayment obligations - you now will go way beyond asking for more time or reduced debt. You now will negotiate with your creditors from a more convincing position, which you desperately need. Your workout plan shows an understanding of the problems, meaningful steps to address issues, measurable benefits and remains simple and easy to communicate. This gives them a better chance of getting more of their money back. You are in essence removing as many excuses or obstacles in their way for not co-operating with you and reaching a workable compromise.

These are the key ways in which this additional scope adds value to the debt workout for both debtor and creditor.

  • This is much cheaper than any rescue or foreclosure, which the business will be more likely to avoid.
  • The methodology we employ targets hardcore survival and cash flow initially, but also addresses issues directly allowing the business to emerge a going concern
  • We show how you will realise the benefits with simple action plans
  • The tactics employed are tried and tested, and come packaged with examples, and templates for easy use and adoption on the business.
  • We drive self-funding removing the need to have additional working capital invested in the business
  • We will work with you and coach you through as much of the work as we can ensuring knowledge transfer
  • We have access to funding and are willing to put our money where our mouths are, we will buy the debt if your creditors are unwilling to compromise
The dimensions of a successful loan workout

Your Workout Focus Areas

This is not about asking for more time or reduced debt, it's about showing how you are implementing remedial steps to assure your creditors and at the same time to re-invigorate your business to thrive in the future!

We apply much of the insight and many of the tools we use in business turnarounds and performance coaching. Have a look at the coaching sections to see the tools, templates, tutorials and self-help available to you. Go-ahead and use these yourself immediately, they are there to be used freely.

  1. Cash & Value management
  2. Strategy & Planning
  3. Operating Model and the Value Chain
  4. Key Processes - monitoring, ownership and removal of waste
  5. People management, accountability, incentives and structures
  6. Personal Development and Leadership
  7. Institutional habits, alignment and communication
  8. Reliable execution

Driving Sustainability

After all the initial hard work on austerity, you must capitalise on these efforts and take your business to the next level. You will address, the following typical problems that are usually the root of the initial business performance issues,

  1. Problems of delegation and team-building - As a business grows and succeeds the role of the management must evolve accordingly. This manifests itself in needing to control, not letting go, and the failure to delegate to a team better equipped to do what needs to be done. Success, growth and size create non-linear complexities for a business leadership, which too often operate at inappropriately low and operational levels. (Test time horizons with diary planning, as well as ratio of difficult to easy decisions needing to be made? )
  2. Poor data - We are entitled to our own opinions but not our own facts. Facts require data, and the business strategy and management of a business, always requires data that is clean, used consistently and available on time. Bad data prevails when business folk are not asking the right questions! – a leadership failure.
  3. Structure - A business is nothing more than a large team of people, relying on each other to do what is required and expected of them in a consistent manner, the outcome of which customers use to solve their problems or make their lives easier. This needs clear delineation of responsibility, clarity about hand-over points, everyone to understand their role, and to be held accountable and be rewarded for their efforts or lack thereof. This problem is made worse by rule based cultures rather than principle based ones (which understand the difference between assigning tasks, and delegating results based on principles)
  4. Thought leadership - Whether because of recent success that attracts the attention of competitors, or a change in economic conditions from the benign to the difficult; predicting trends, understanding consequences, out-maneuvering the competition, taking longer time horizons, dealing with complexity and generally leading (not managing) a business, demands a different kind of thinking rather than merely the operational that is the refuge of managers in whom the business has not invested sufficient time to equip them.

How to effectively include all stakeholders

Managing the actual rehabilitation actions is often easier than managing the crowd of affected parties. In the worst case scenario you might well have tax liability and SARS, a disgruntled regulator and fines looming, a labour union, your supply-chain and trade creditors and a bank, as well as interested 3rd parties, the press and others sensing opportunity waiting in the background. This is way the key enablers and principles to be embraced are critical to this approach. The on-boarding of every party and the clear communication of the process and the tools/channels of communication are vital. Get it right and you will reduce the effort required in communicating and getting decisions ratified, get it wrong and you will delay the process and frustrate everyone. It is essential that time is invested upfront, and the skills of a strong, credible and aligned legal team are part of your planning (and involved from the start), as well as a dedicated project manager with support to manage the process is highly advisable. Revisit the key enablers and principles needed for success and then with this in mind walk the process to see how you can get this done effectively.