Three Challenges with Loans and Debt Restructuring

From my front-row seat as a consultant specializing in distressed company debt restructuring, I can point out three challenges affecting the current environment for business loans and restructuring:

Borrowers are receiving less responsiveness from banks who outsourced loan administration while trimming the ranks in-house staff.

We have also seen an instance where the push-and-pull of negotiations slowed to a grinding halt as the lender rotated outsourced work from one firm to another, essentially forcing a do-over of facts, figures, and assumptions while the new firm got up to speed.

Requests for lien releases in the context of an asset sale have become complicated ordeals.

The SBA is hardly flexible when it comes to restructuring of debts that are covered by their blanket lien on all assets. The prevalence of SBA loans stemming from Covid-era government financing has increased the number of cases where UCC lien releases require specialized expertise. As a result, assumptions of what a bank may or may not do are less certain these days.

Technology such as auto-debits do not easily conform to the established norm of lender-borrower loan workouts.

We heard of a printing company loan workout where the lender was incensed when it learned that the treading water borrower allowed unsecured creditors to be paid ahead of the bank. The excuse that the controller was unable to turn off the auto debits for credit card payments fell on deaf ears.

Decoding Buyer-Seller Financial Dynamics

 

 

Your Money - Who Wants to Know?

Balancing Disclosure and Risk in Printing Industry M&A

Imagine you are buying a house, and the seller demands to know your remodeling plans and projections for future resale profits. In residential real estate, that request would likely be met with skepticism.

However, in the world of mergers and acquisitions (M&A), especially within the graphic arts and printing industries, sellers often expect a deeper look into a buyer's plans. Why? Because M&A deals often involve complex payment structures, such as earnouts, royalties, equity rollover, or contingent notes, all of which make the seller a future stakeholder in the buyer’s success. If the seller will be leasing property to the buyer or remains employed post-closing, their interest in the buyer’s financial health becomes even more justified.

Why Sellers Want Buyer Information

When sellers are offered performance-based consideration rather than guaranteed money, their future asset monetization depends on the buyer’s success. Therefore, they reasonably want to evaluate the buyer’s financial viability and growth plans to ensure that the business strategy is sound and that the buyer can fulfill their obligations.

Common questions asked by sellers include:

• Does the buyer have sufficient ability to finance future capital investments to grow the business?
• What’s the buyer’s transition plan?
• Does the buyer’s bank agree with projections for consolidation savings?
• How much working capital will be required post-acquisition?

Earnouts and All-Cash Deals

The choice of payment structure significantly influences the level of scrutiny from the seller. When an all-cash deal is on the table, the seller typically has no stake in the future business performance, reducing the need for in-depth buyer disclosure. The transaction is straightforward—the seller gets paid, and the buyer takes on full ownership risk.

However, all-cash deals are rarely available to sellers in the absence of stellar financial statements or a deep discount to fair market value. A word of caution for sellers: requiring an all-cash deal is an invitation for low offers. That’s because customer retention risk is inherent to printing industry M&A. Sharing of the customer retention risk is usually in the seller’s best interest to entice the highest possible offer. It is the role of the M&A advisor to balance the price and structure of the transaction to fairly allocate performance-risk.

Given that most acquisitions involve some form of risk-sharing, sellers want to know that the buyer’s plans  are feasible to achieve. Sellers want to assess the probability that performance-based consideration will actually be received.

The Value of Financial Transparency

As a buyer, it may be tempting to push back on seller requests for financial information but sharing select details early in negotiations can build trust and smooth the path to a successful deal. Buyers who provide financial statements, demonstrate creditworthiness and show strong supplier relationships can reassure sellers of their ability to deliver on future payments.

This mutual disclosure fosters a partnership mindset, where both parties are committed to the success of the deal and the post-M&A closing transition.

Planning for Financial Disclosure

Buyers can increase their chances of success by preparing financial documentation in advance. This homework includes consulting with their bank to confirm financing readiness and securing a solid credit rating. By being proactive, buyers signal seriousness and professionalism, which can lead to more favorable deal structures and stronger negotiating positions.

Financial transparency between buyers and sellers is the norm in graphic arts and printing company mergers and acquisitions, especially when earnout provisions or other risk-based payment structures are involved. Both sides are advised to share key financial details to build trust and ensure a successful acquisition. Buyers and sellers alike need to be prepared for two-way financial disclosure, helping them navigate M&A transactions with clarity and confidence.

Ultimately, the more informed both parties are, the higher the likelihood of success for both buyer and seller.

Considering a Merchant Cash Advance for Your Company? Beware!

What is a merchant cash advance?

A merchant cash advance is a lump-sum payment from a lender based on future credit or debit card sales. It’s different from traditional bank financing and distinct from alternative financing like factoring or asset-based lending, which have been around for a long time. In the realm of financing options for companies struggling to keep up with their loans and leases, merchant cash advance loans are far riskier because of the onerous terms and conditions often obscured in the legalese fine print.

Why has there been a rise in the popularity of merchant cash advance lenders?

They are easily accessible online with a relatively simple application. The process is nowhere near the depth or scope required for bank financing or asset-based lending.

What are their lending criteria?

Most merchant cash advance lenders don’t examine the company's cash flow. They do not assess the company’s balance sheet, nor do they ask probing questions about business viability. They focus on the creditworthiness of the underlying customer of the borrowing company.

What are the costs?

Merchant cash lenders charge high interest rates and various fees, making the overall cost of money extremely high. When you break down the dollars-in versus dollars-out over the duration of the loan, you realize just how expensive it is.

This is short-term borrowing to get out of a bad situation. I suggest that these loans be viewed as rented equity investment. It’s a new money infusion to fill a gap in the capital structure of the business. Long-term revenue decline, peaks of profitability and valleys of losses, capital expenditures that have not yet generated sufficient return on investment, and other structural financial setbacks can result in the moment in time when the situation looks bleak. At these times, the cost of new money is measured against avoidance of greater harm such as running out of money and having the doors shut on the business. Merchant cash advances are often the last resort for borrowers, venturing into a quasi-street-money world of lending.

If the company is solvent and making money, this kind of lending does not make sense. But for companies struggling to survive, it can be a necessary, albeit expensive, solution to an immediate need. An example of one such situation might be the company’s health insurance is about to lapse and employees will lose their healthcare coverage. A merchant cash advance might be a better alternative than having employees’ claims go unpaid.

These loans fill the need for survival money at a critical juncture and should only be used as a last resort.

What alternative directions could companies consider instead of thinking this quick fix will save the day?

Many business owners who turn to merchant cash advances have already exhausted other alternatives. They have leaned heavily on trade creditors, deferred lease payments, and cut overhead. I suggest reviewing restructuring options before jumping into the world of merchant cash advances.

How do these lenders see themselves?

Some merchant cash advance lenders see themselves as a technology solution, akin to Uber or Lyft in their respective industries. They position themselves not as lenders but as future accounts receivable purchasers, entering into a contract with your company to acquire new invoices being generated. They claim it's a contract for the future purchase of receivables, not a loan, and thus they don't need to act like lenders. However, merchant lenders will most often file UCCs to make their presence known to other lenders and any prospective buyer of the business.

(A UCC filing is a document that lenders use to establish their legal right to assets that a borrower uses to secure a loan, allowing the lender to seize the borrower’s collateral in the case of default).

Their position that they are not lenders of money has major implications for financial restructuring, whether the process involves bankruptcy, secured party sale, or non-bankruptcy orderly wind-down.

In the end, how do they collect their repayments?

In addition to high interest rates and fees, their tools for repayment and debt collection are what make them truly toxic to vulnerable businesses. It’s critical to understand these lenders repay themselves through daily auto-debits from the company's checking account. Until this actually starts happening, it’s difficult for borrowers to really appreciate how hard it is to manage cash flow when there is a daily auto-debt right out of the checking account.

By definition, the company that's short on funds now has to navigate the juggling act of receivables and payables along with looking at the bank account to see what auto debit is hitting today. This daily debit adds a layer of complexity to an already difficult situation.

If someone is looking to buy a company, should they ask about merchant cash advances? How can they identify them when digging into the financials, and what is their responsibility if they purchase the company?

The implications of merchant cash advance loans in buying or selling a company are serious. The M&A buyer won't want to take on the seller's responsibility for merchant cash loans. Identifying these advances is crucial, but they may not even appear on the balance sheet. And, if they do, there is often a variance between what the borrower thinks is the payoff amount and the actual amount the lender insists upon receiving.

What can happen if you fall behind with a merchant lender?

The small type in merchant cash advance agreements often gives the merchant lender the right to contact the company’s customers directly in a default situation. This can create irreparable damage to the company’s reputation and jeopardize the sale of intangibles to a potential M&A buyer. We had a recent case in which the M&A buyer had to go to bat against the seller’s merchant cash advance lender who was sending legal hardball notices to the customers. It was resolved, but only after an intense effort to push back on this over-the-top aggression.

Special Situations and Debt Restructuring in the Printing Industry

 Graphic Arts Advisors, LLC, M&A advisors and consultants to owners, lenders and investors in the printing, mailing, packaging, digital advertising, and graphic communications industries, is pleased to present a conversation with John Hyde, Esq., Managing Director of Special Situations, the leading expert in M&A involving financially-challenged companies in this marketplace.

Q: Your colleagues at Graphic Arts Advisors and others in the printing industry say that market conditions are currently positive for mergers and acquisitions. Do you agree?

JH: Yes, the current M&A marketplace is robust for businesses sold as a going concern or as a tuck-in. In most cases, buyers are placing significant value on the intangible assets such as customer relationships, the book-of-business, market presence, qualified and trained employees, and functioning infrastructure with installed equipment up and running.

Q: What does this mean for owners and investors of companies that find themselves financially “upside-down,” owing more in debts than they can reasonably pay off?

JH: If the company’s assets are worth less than what is owed to creditors, then the owners or investors face lousy options such as using personal savings to pay the shortfall, slog it out in bankruptcy court, abruptly walk away with resultant reputational harm and risk of legal action, or negotiate amicable and fair debt settlements in a structured process outside of bankruptcy court. The latter option, often known as non-bankruptcy debt restructuring, is usually less painful than the other more extreme measures. Non-bankruptcy debt restructuring is ideally suited to owners and investors of financially-challenged companies who prefer to achieve a graceful transition that is amicable for customers, employees, suppliers, lenders, investors, partners, and landlords.

Q: What do you mean by “restructuring”?

JH: Restructuring is the art and science of substituting one obligation for another. It often involves a process designed to negotiate fair settlements with creditors as part of a comprehensive plan.

Q; Is it a legal term?

JH: Yes and no. There is no exact legal term called “restructuring”, but professionals engaged in the practice incorporate elements of federal bankruptcy law, state creditor rights laws under Article 9 of the Uniform Commercial Code, state laws related to real estate foreclosure, and plain-vanilla contract law. Restructuring in practice goes beyond legal principles by factoring into the mix financial, legal, tax, accounting, corporate, psychological, reputational, family, and ethical considerations.

Q: Is “restructuring” legally binding like in a formal bankruptcy case?

JH: It can be if carried out under the auspices of a court-appointed receiver or trustee, but “restructuring” as a trade craft is broader in meaning. It includes unspoken understandings, subtle nuances, and an extensive treasure chest of tactical opportunities based on what works and what doesn’t work in these kinds of cases.

Q: When do company owners and investors need to consider non-bankruptcy debt restructuring?

JH: Non-bankruptcy debt restructuring is worth considering in situations where too much debt prevents the owner from simply getting out from under. It is applicable to M&A scenarios, but it is also used when M&A is not feasible, desirable, or fast enough. It is not uncommon for a buyer’s M&A offer to leave the potential seller with significant retained liability. Non-bankruptcy debt restructuring fills the void so the valuable parts of the business can be sold and transitioned to a strategic acquirer.

Q: Does this mean that the financially challenged seller can accept an M&A offer that does not cover the debts?

JH: The value placed on intangible assets such as the customer relationships, market presence, book-of-business, qualified and trained employees, and equipment up and running, provides a form of currency. Intangibles value is frequently combined with equipment sale proceeds and monetized retained assets such as AR and real estate, to create a pool of funds from which necessary expenses are paid and debts are settled in a fair manner. A graceful transition does not require every debt to be paid in full. Settlements need to be fair, but not necessarily full payment of debt.

Q: What about where there are enough assets, but it is going to take time for money to come in?

JH: Non-bankruptcy debt restructuring is an appropriate option if the debts are due before the assets can be monetized. There may not be enough cash at the M&A closing or in the bank on final day of operations to take care of everything at the same time. That doesn’t mean the price was too low or that the assets aren’t worth enough. Many sellers negotiate a fair M&A deal that supplements the cash received at closing with future payments from the buyer in the form of an earn-out, royalty, or promissory note. However, typical creditors (bank, suppliers, leasing companies, credit cards, and landlords) expect payment much sooner than when those future payments would come in. Restructuring is often a process intended to align timing expectations with reasonable forecast of future money that would come from the M&A buyer or other asset sale transactions by seller, effectively a payment plan based on a future likely stream of income.

Q: If there’s too much debt or the creditors will have to wait for payment in the future, why not just file for bankruptcy or walk-away?

JH: Very few cases in our industry are good candidates for bankruptcy. Legal costs are one prohibiting factor, but even more so is that every creditor would have to be treated the same within certain classes of creditor. Treating all creditors alike regardless of who they are without context, background, history, and past relationship does not resonate with owners. There is something fundamentally different about the big paper houses, the local mailing house, the die cutter down the street, and the freelance designer who saved a customer by touching up a job at night. Credit cards, office supplies, freight invoices, and click charges are just not the same.

Q: It sounds like flexibility, affordability, and discretion are more readily found in non-bankruptcy cases, is that right?

JH: Non-bankruptcy debt restructuring offers greater flexibility than bankruptcy, to a point. There has to be fairness, and formal bankruptcy is the unspoken backdrop to negotiations. It is up to the skilled advisor to read the landscape properly in crafting the plan that accommodates different interests. I am not a bankruptcy lawyer, but I do look at the bankruptcy options. The first phone call I receive often comes after an owner has just received a bankruptcy consultation and did not like what they heard.

Q: Why are there are so few bankruptcy cases in this industry?

JH: In addition to the requirement to treat all creditors equally within certain classes and the high legal fees, the icing on the cake against bankruptcy is that survival in our industry is hard enough without competitors waiving your chapter 11 petition in your customers faces. Customer’s perceived risk of sending a job to supplier that is operating in bankruptcy is huge. In some of our industry segments that involve privacy laws and data security, such as transactional printing, bankruptcy is contractually immediate grounds for termination of the relationship. In other words, the value of the company’s intangible assets, its customer relationships, is more negatively affected by a bankruptcy filing than it would be in non-bankruptcy debt restructuring.

Q: How about when an owner that wants, or more critically, needs to sell their company and is under the gun to sell quickly due to the mounting debt load?

JH: In these instances, we can run a dual process in which our special assets team plans out the restructuring and work with the creditors to extend the time frame, while our other partners run a robust sale process to find the best offer for the business assets. Notably, creditors, especially the secured lenders, will appreciate that the sale is being conducted by industry-specific specialists in a transparent, arms-length process. That makes a tremendous difference when the secured lenders are asked for forbearance or other concessions.

Q: How do you assess the current receptiveness for settlements from lenders, trade suppliers, and other creditors in these situations?

A: Creditors’ expectations for payment in full are high in today’s climate. Expectations were high in 2018, then came down significantly in the early stages of the pandemic and have since rebounded. As in pre-Covid times, there is little tolerance for a plan that gives creditors five cents on the dollar while the former owner walks away with their shirt on. That said, this is not a climate in which hard-ball tactics are used to punish owners that are in a difficult financial position. We find that our clients are coming out okay as long as they can substantiate a well-presented offer that is fair and reasonable in the particular case.

Marketing in the Time of Covid – A Restructuring Novella

Times were good before anyone ever heard of Covid-19. Our client, a Harvard-educated CEO, had raised a tidy sum of venture capital from investors in technology companies. Marketing automation technology was all the rage, and the bet was on building a better mousetrap, with a high-multiple business valuation on the short-term horizon.

Covid changed everything. Focused on the entertainment and events industry, the company started racking up losses in the early months of the pandemic. Revenues ground to a fraction of pre-pandemic levels. Despite generous government aid programs, returning to profitability turned out to be elusive.

The CEO’s options shrank as cash reserves dwindled, and the investors’ patience ran low. It became apparent that fixing the company was unlikely and the CEO called a friend who in turn referred him to me and my colleagues at Graphic Arts Advisors.

An initial assessment revealed that while the enterprise was headed for a crash landing if immediate action was not taken, there was nonetheless sufficient gas in the tank to commence a sale of the core book of business. For a strategic sale of assets to take place, we advised that the company reset its focus from mining growth opportunities to retaining key employees and safeguarding customer relationships. Preserving capital became management’s top priority. Facing an unfamiliar journey, the CEO nonetheless quickly grasped arcane legal concepts such as corporate officers’ fiduciary duty to creditors when a company enters the zone of insolvency. Paying ordinary operating expenses now required an understanding of the impact of not only corporate insolvency laws, but also a rigorous and rolling analysis of projected sources of cash and uses of funds.

Five months of intense work later, the CEO took a deep breath and could finally relax, as he safely landed the plane with barely any fuel remaining in the tank. The sale of intangibles from the M&A transaction generated cash to cover most liabilities, customers did not miss a beat, employees always received paychecks with all taxes paid, and creditors were treated fairly and with transparency. The post-M&A closing orderly wind-down process would monetize retained assets and satisfy liabilities, ensuring a graceful transition without reputational harm or messy lawsuits.

A behind the scenes look at the M&A strategic transaction involving the Distressed Marketing Agency (aka “DMA Advertising”) and the buyer (aka “Acquisition Graphics”) offers relevant insight for owners, investors, and senior managers of companies who face critical decisions on the decision to maximize business value against the backdrop of red ink that often results from declining revenues.

Readers of The Hyde Opinion can take away five lessons learned that may be instructive for other distressed companies weighing their options:

1) Stay Focused on Desired Outcome for Sale of Business

DMA Advertising’s Board of Directors and senior management team had recognized the potential benefits of joining forces with a strategic partner, and they acted with sound decision-making grounded in objective analysis. Once the decision was reached to find a buyer, the sale-of-business process received front-burner attention each day. As a company owned by investors and run by professional managers, DMA Advertising did not become distracted by family considerations that may affect the M&A process where family members wear various hats and juggle responsibilities, often clouded by overwrought emotional responses. The professional managers refrained from delay-inducing second-guessing or seller remorse. There were emotional moments, but they did not side-track the intense work schedule that was set in motion when the CEO gave the green light to launch the M&A outreach campaign for procuring a suitable buyer.

2) Steer Away from Bankruptcy Unless Stopping Collection is More Important than Customer Perception of Business Viability

The primary reason why few companies in the printing, packaging, mailing, marketing services and graphic communications industries file for bankruptcy is that the out-in-the-open legal process tends to negatively affect customer relationships. Rather than preserving business value, bankruptcy itself is likely to rapidly diminish the value of the intangible assets. In this case, the seller avoided losing time and focus by quickly ruling out a bankruptcy scenario. To cover all the bases, the CEO obtained a one-hour consultation from a highly respected bankruptcy lawyer. Some of the investors had already obtained advice that the M&A value of DMA Advertising’s customer relationships would be difficult to monetize if the sale process was conducted under the bright lights of a bankruptcy auction. The second opinion from the bankruptcy lawyer was sufficient to confirm the opinion that customer relationships would rapidly deteriorate as word spread that the trusted marketing vendor had landed in bankruptcy court. 

3) Carefully Orchestrate Selection of Buyer Candidates to Maximize Opportunities while Minimizing Inadvertent Public Disclosure

My team at Graphic Arts Advisors worked very closely with DMA Advertising’s senior management team to identify and communicate with potential buyer candidates. The process was collaborative and enabled the CEO to tap into his own strategic contacts while not losing valuable time in exploring one-off opportunities. The CEO resisted the temptation to artificially limit the bandwidth of the outreach communications. No candidates were deemed off limits, however the list of potential strategic partners was intensely scrutinized by the management team before the formal approval to initiate contact, The M&A outreach process was carefully managed and documented. The investors were kept informed.

4) Maximizing Business Value Sometimes is Best Achieved Through Lightning-Quick M&A

Given DMA Advertising’s limited survivability as time and money were drying up, the M&A outreach process was condensed so that it took only 120 days, from start to finish, as compared to 9 to 12 months in most non-distressed company sales. The combination of the CEO’s business intelligence within their niche and my team’s research capabilities yielded nearly thirty preliminary expressions of interest on a highly confidential basis. DMA Advertising received three bona fide offers. The managed sale process achieved its desired outcome of competing offers, each of which required careful assessment. Detailed documentation of the sale process satisfied the board of directors which demanded a rigorous process to ensure liability minimization. The value of the assets was established and confirmed by the market.

5) Timely and Accurate Financial Information was Consistently Provided by the CFO

DMA Advertising’s senior management operated in a highly efficient, coordinated, and effective manner at each step of the sale process. Delay was virtually non-existent. This gave buyers a high comfort level, and, more importantly, DMA Advertising avoided burning precious time and cash. It is worth noting that the CEO was able to provide revenue projections by customer, with reasonable assumptions backed up with emails or other supporting material. The quality of the customer revenue projections enabled the seller to negotiate a more favorable cash component to the transaction than otherwise expected in a distressed company M&A sale. Not only did the quality of DMA Advertising’s information enhance the sale process, but the detailed analysis also facilitated planning for the post-M&A closing orderly wind-down. Detailed spreadsheets showing sources and uses of cash provided clarity and accuracy as to how the assets and liabilities would unwind with or without M&A. In this case, preparation for a post-M&A closing orderly wind-down was instrumental in maximizing the value of seller’s retained assets (receivables and work-in-process), minimizing cash burn, and settling liabilities without litigation. 

All these factors contributed to a graceful transition that involved customers, employees, and suppliers. If certain performance metrics are achieved by Acquisition Graphics after the integration of DMA Advertising, there is potential for increased value in the form of additional cash payments which would benefit seller’s investors.

After the M&A closing, the CEO regained the color in his face, and, in reflecting on what had been accomplished, and with a sigh, exclaimed “they sure do not teach this kind of stuff in business school. I now understand why: no one would believe that this really could happen.”

A Reality Check to Better Understand Worst Case Scenarios for Owners

Worst Case Scenarios are Misunderstood

Those of us who make a living in the printing and graphic communication industry hardly need reminders of how hard it is for businesses to survive and grow. Even the owners, senior managers and investors in successful establishments recognize that fortunes can change for the worst case in an instant. 

The path from “healthy company” to “treading water” company can happen in a myriad of ways. It may start with a large customer downsizing its print marketing budget or with the departure of a key salesperson or with the news that a good customer has sold its business to a company that has its own supplier base to feed. The downward spiral can be set off by paper procurement challenges, as many companies struggle with this current dilemma [See, “Four Extreme Measures” below]. I sometimes remind myself that the owners of “treading water” companies who become my clients for non-bankruptcy debt restructuring or orderly wind-down of their business never thought they would ever need this kind of expertise. 

Perhaps you are reading this while enjoying success and just want to feel a little safer in pondering “what if” scenarios. Maybe your spouse is seeking reassurance about the future. Or maybe you and your partners are not on the same page about the direction forward and want to hear what is being said about others experiencing “worst case” outcomes. It could be that your company is seeking to grow by acquisition, and you are looking to learn valuable insights for connecting with owners of struggling companies. 

Whatever your reason for checking in, there is one—and only one—takeaway from this article: Worst case scenarios are misunderstood.

This is not a criticism of anyone. It is a statement about how hard it is to determine the path for graceful transition from ownership when it is out of necessity, such as when the sale of business or bankruptcy, are not attractive alternatives. This is similar to reading up on health issues that make the patient more informed to speak with a heart specialist. Do-it-yourself knowledge about bankruptcy, for example, may suffice to a point, but usually the “rubber-meets-the-road” issues are specific to the facts of the case. They require critical assessment by an industry-specific professional advisor who does this kind of work every single day.

FIVE COMMON OWNER MISUNDERSTANDINGS

IN CHALLENGING SITUATIONS

Statement: “I don’t have any personal guarantees to lenders, so I’m not worried if the business has to shut down.” 

Reality Check: Owners face threats of personal liability even if there are no personal guarantees. An owner is missing the “big picture” when believing that he/she can sleep at night because there are no loans or leases involving personal signatures. Sophisticated creditors can find “hooks” into the business owner based on actions or inactions that involve legal ramifications. One example is where the company took on new debt, such as paper bought on credit, where the business owner knew or should have known that the company will not be able to pay it back due to its worsening financial condition. Creditor settlements in non-bankruptcy cases almost always take into account this kind of personal liability risk; often unknown to the client. 

Advice: There is a series of similar “hooks” that only a seasoned professional can identify so that the merger and acquisition (M&A), and restructuring, can be planned with a view toward minimizing risk. Just saying, “I don’t have any personal guarantees so I’m not worried” is unwise. Personal guarantees expressed in contractual agreements with lenders was an issue in about half the non-bankruptcy orderly wind-down cases that I worked on in the past 6-12 months. Non-contractual personal liability was an issue in a third of the cases. Sometimes the personal liability stems from taking too much money out of the business in prior years, or it may arise from the timing and circumstances of purchasing paper and materials, or from inaccurate understanding of lease documents. The details on how assets are titled, the creditors that have filed liens, and who is responsible for liabilities, is based on careful review of documents. These are essential inputs in creating the “road map” for ceasing operations and the orderly wind-down of the company.

Statement: “My accountant says I have enough assets to get out from under the debt even if the company has to close down.” 

Reality Check: The accountant may be right about getting out from under debt, but industry-specific expertise is needed to assess several critical considerations before the client can safely rely on the accountant’s advice. In our “Second Opinion” evaluations, we find that there is a general lack of insight among professionals in understanding customer obligations such as deposits, postage, and work-in-process at the time of transition; the hidden costs of disposing of equipment including labor to run a press for showing it to equipment buyers; and the working capital necessary to implement the post-closing wind-down. This is all in consideration that there are expenses to be incurred beyond what is accrued on the balance sheet (one example: three to six months of infrastructure bills from the day of ceasing operations as a going concern to the final day in which assets are disposed).

Advice: The good news is that the value of intangibles are also misunderstood by many professionals who are not well versed in printing industry-specific M&A and restructuring. The value of customer relationships (the so-called “book of business”) does not appear on a balance sheet, leading to potentially devasting results. We had a client come to us, saying his accountant thinks he should just shut the business down now without any M&A. It turned out that the sale of intangible assets was in seven figures, making a huge difference in the ultimate outcome. It would have vaporized if the client did not seek a second opinion from a qualified expert in distressed company M&A.

Statement: “We can just shut down and take the customers over to another company where we’ll get equity.” 

Reality Check: The press operator would not even think about taking home the press, so why are some owners thinking that they can just take the customers with them when they leave the company? Except in cases with specific facts, customer relationships and data files/estimates/job tickets etc. are corporate intangible assets. It is a fallacy to believe that customers are NOT assets just because they are free to choose any supplier. Simply, a contract is not necessary to demonstrate that the customer relationship is an asset. This issue often comes up with salespeople, and it is the same point: customers are corporate assets. The owner may say: “But I started this business, all the customers know me. They will go with me to a new home.” Yes, but, depending on the facts, the value of customer relationship assets belongs to the corporate entity, not the owner directly.

Advice: If the company is insolvent, as determined by an industry-specific liquidation value analysis, then the creditors, not the owner, are entitled to the value of assets. The owner then could say, “no one will know” or “we can use some of that value to make settlements with creditors.” The latter has the hallmarks of a potentially good candidate for non-bankruptcy orderly wind-down of assets and liabilities. The former has the hallmarks of a potential litigation case for creditors to pursue against the individual personally, thus inadvertently creating a “backdoor” personal guarantee where there had been none.

Statement: “I’ve heard that the leasing company will just take back the equipment and we’d be done with them."

Reality Check: Although the occasional instance may arise where surrendering the equipment back to the lender is the final settlement. The underlying reality is that equipment lease obligations do not magically disappear simply because the equipment is given back to the lender. And “one size fits all” definitely is NOT the reality when it comes to guiding the client through the lease settlement process. Equipment lease negotiations are fertile ground for overstating what can or cannot be done.

Advice: A deep dive into the overall facts of the case is necessary. Solutions are not in the legal documents, but the legal documents must be reviewed carefully as part of the assessment of options.

Statement: “We’ll just close the doors and creditors will get nothing.” 

Reality Check: Owners who gloss over the complexity of financial restructuring on their way to “dreamland” may be surprised when creditors pursue aggressive legal action to collect from the company’s owners, officers, and directors even without personal guarantees. In fact, the more cavalier the owner’s attitude, the greater the likelihood of lawsuits involving breach of fiduciary duty, unjust enrichment, and fraud. By contrast, a comprehensive approach to treating creditors fairly is highly likely to succeed if the plan is designed and implemented by an industry expert.

Advice: Owners who want to treat creditors fairly, stand a much greater chance at an amicable parting of the ways with suppliers than owners who think they are entitled to take advantage of the situation as payback for years of paying supplier invoices.

This edition of The Hyde Opinion originally published by the Raymond J. Prince Graphic Communication Advisors Group

Paper Supply Constrains Industry

Recent feedback from owners of printing and graphic communications companies have led me to reflect on business viability implications of shortages in the paper marketplace.

Over the past several decades, printers have come to rely on and trust that a steady source of quality paper will be available on demand. This assumption has been changed, maybe forever, as a new reality confronts decision-makers across the spectrum of print-centric companies.

Paper supply has recently become a challenge regardless of a printing company’s annual revenues, or whether the company ownership consists of family members, business partners, or investors. “A refrain is now heard throughout the printing industry,” wrote Mark Hahn in The Target Report (See Printing Papers Get Squeezed Out – February 2022 M&A Activity), “paper supplies are very tight, allocations limit the ability to take on new customers, discounts and rebates are a thing of the past, shipments are delayed until price increases take effect, and printing and packaging companies increase paper inventories at every opportunity. The supply and demand curves have crossed, and the mills are in charge.”

According to Mark Hahn, my partner at Graphic Arts Advisors, “There are several reasons pricing leverage has shifted to the mills, including a labor strike at Finnish papermaker UPM, Covid-related supply chain disruptions, shortages of drivers, all in addition to the numerous closures of paper mills over the past several years.

“The paper industry has been chasing falling demand across the printing grades for a couple decades, closing mills, seeking to regain pricing leverage,” Mark wrote in The Target Report. “With the uptick in online purchasing and increased consumer spending across the board during the rebound from the Covid shutdowns, the stage was set for the significant shift in paper manufacturing now well underway. The result is that shuttered mills have reopened, and in the process, transitioned to packaging grades. Underperforming mills are purchased, and the new owners reconfigure the paper machines away from printing paper grades and to containerboard or kraft papers. Paper making operations are large and capital-intensive; the moves are major sea changes and will not be easily reversed. The result will be tight supplies of printing grade papers for the foreseeable future.”

Leading Companies Will Pull Ahead

One can view the current paper situation through the lens of long-term fundamental changes that have affected the printing industry, among others, the transition to electronic prepress, emergence of production-level digital printing, and migration toward internet-based job ordering. It is well documented that fundamental changes in the industry as well as economic events (such as the aftermath of 9/11 or the Great Recession) served to create distance between leading companies and those who are treading water. The gap widened considerably with the outbreak of Covid-19, as many companies struggled to survive. For some printing companies, Covid-19 created opportunities to take market share from those who could no longer compete. Factors that made a difference include the specific vertical markets a printing company served, retention of talented employees, and the strength of its balance sheet going into the crisis. The strong became stronger, the weak became weaker.

As the impact of the PPP loan and Employee Retention Credit programs fades, the gap between winners and losers is likely to be revealed. It stands to reason that the paper shortage will impact the weaker players more, at exactly the time when these companies need to reestablish viability without the largess of Federal government giveaways. Once again, the gap has widened between leading companies and those treading water.

The paper shortage is particularly troublesome because it impacts an entire organization, including salespersons, customer service reps, plant management, procurement professionals, production staff and ownership. Pressure is being applied to printing companies on both sides of the print production supply chain; customers seeking to confirm orders on one side and paper vendors juggling demand that exceeds availability on the other.

	Paper Availability - Warning Signs Flashing Red Alert
	1. Declining Profitable and Desirable Customer Orders Due to Lack of Paper
	2. Deadlines are Missed Because Paper Order is Late or Canceled
	3. Pressure on Profit Margins Due to Inability to Pass Along Paper Price Increases
	4. Customers Switch to Electronic Media Channels Due to Declined Print Orders
	5. Meeting Schedules with Multiple Makereadies but Customers Will Not Pay Extra

Turn a Negative into a Positive

As we speak with companies across the US, we hear that even strong companies are being tested to navigate the maze of options and solutions to procure adequate paper to meet customer requirements and deadlines. Within the broader set of problems, there are also opportunities.

We know of one client in California who tweaked their inventory reporting system by adding a visual display to paper pallets in the warehouse. The signage, with the date of purchase and the cost of paper, matched the paper to specific customers for jobs scheduled months in advance, a cash-draining change for a company that was accustomed to real-time paper procurement. The new signage was a component of an awareness campaign to optimize working capital management in other areas to offset the cash now tied up in paper inventory. The result was improvements in press productivity, waste reduction, and in the front office, faster AR collection. In essence, the paper shortage became a rallying point for the troops who responded favorably.

Another client, a successful family-owned printing company in the Carolinas, noted that they successfully increased their internal manufacturing hourly rates in addition to obtaining an increase to cover paper costs. The general awareness of inflation, coupled with publicly announced paper price increases, created the opportunity to address the previously uncomfortable topic of price increases. As print customers learn that their print suppliers will gladly use their paper allocation to serve other customers, resistance to price increases has softened. Print buyers that go price shopping find that print suppliers cannot, or will not, allocate limited paper availability to bottom-fishing buyers. This has created the opportunity for across-the-board price increases, including internal rates attributed to labor and production costs.

   

	Paper Availability Affecting Business Viability - What to Do
	1. Arrange for Rapid Financing from Family & Friends Supported by Private Lender Legal Structure
	2. Form a Strategic Alliance & Outsource to Compatible, but Stronger, Business Partner
	3. Implement a Lightning Quick Sale of Challenged Business to Preserve Remaining Value
	4. Plan for Graceful Transition from Ownership Before a Sudden Shut Down is Unavoidable
	5. Avoid the Expense & Reputational Harm of Bankruptcy & Plan for Orderly Wind-Down

A client in the Midwest has augmented their M&A outreach program with offers of management, financial, and production outsourcing support to prospective acquisition targets that they know are struggling to obtain paper. This communications messaging is essentially the 2022 version of the time-tested strategy of enticing struggling target companies with much needed relief as inducement to respond to the buyer’s solicitation of interest in M&A.

Contact John Hyde, Esq. for a confidential discussion of any of these or other options (john@graphicartsadvisors.com; 646-220-4431).