Case Studies: Growing Business but Losing Money

Growing Business but Losing Money

A client came to us with a serious problem: he had a growing business but was losing money; his lenders had lost faith in the company. The business had taken on considerable debt to fund specialized machinery that greatly expanded the company’s capacity. Although the business had grown, it still wasn’t operating near its new capacity. The lender’s withdrawal of a line of credit had meant the company moved to a factor to borrow against its receivables, incurring tremendous costs and fees.
We analyzed the situation and found that 1) the cost of capital had grown tremendously as this company had been forced to move to more and more expensive sources of capital, and 2) that the accountant had used a five year life for the new machinery, causing a very high depreciation amount that exacerbated the company’s losses. We were able to convince the accountant to restate the company’s results, according a fifteen year life to the specialized equipment. This action by itself added $1 million to assets and net worth, curing a deficiency in the capital account. Secondly, we showed what the company’s recent history would have been if it had been able to attract capital under more normal terms. In that case, the company would have been profitable, as the nearly $1 million of annual interest cost would have been substantially reduced. We were able to find a new working capital lender, reducing all in costs on the company’s line of credit by 12 points, and to bring in a new mortgage for the building, reducing that rate by 5.5 points. With these new facilities, the equipment lender decided to stay with the company and go forward.

Case Studies: Deposit to Purchase

Deposit to Purchase

A client had just concluded making an acquisition of a business and after two years of renting the facility from the former owner, he was desirous of buying the property and creating a platform for making his occupancy costs more predictable.  The problem was that in accomplishing the initial purchase of the business, the balance sheet had been leveraged beyond what conventional lenders might consider a reasonable margin of safety.  Worse, the client did not have the necessary down payment to seek conventional or alternative mortgage financing.  A solution was identified whereby our client would enter into an agreement to buy the property on a deferred basis and instead of making his earlier rent payments, they would take the form of a non-refundable deposit against the purchase price.  By way of example, if the property was appraised at $1 million, the deposit to buy would be $8,333/month.  At the end of the first year, a deposit of $100,000 would have been completed or 10% of the agreed upon price.  Our client had the option of continuing to extend the deposit for an additional year before seeking financing.  Thus, the purchase price would have been $1.1 million ($100,000 of which would have already been deposited) and at the end of the second year he would have accumulated $200,000 in aggregate deposits or roughly 18% of the agreed upon price ($200,000/$1,100,000).  The seller did not have to declare the deposits as income since they were merely non-refundable deposits and the buyer (our client) did not have to expense the payments as rent, thereby increasing his earnings and reducing the leverage incurred from the initial purchase of the business on a more accelerated basis.  When the deposit to buy strategy was completed, the seller of the property recognized the transaction as a capital gain and not ordinary income, thereby significantly lowering his tax burden.  The result was a win-win for both buyer and seller.

Case Studies: Debt Management

Debt Management

A client was referred to us by a lender in the “managed asset” area of a local bank.  The marching orders were to identify areas suitable for cost reduction and to assist management to develop a strategy to become consistently profitable.  These objectives were accomplished in short order, but it became evident that the debt the business had incurred was more than it could realistically support if it were to become self sufficient.

In light of these factors, we examined the net liquidation value of the primary assets of the business and determined that their value was substantially less than might be obtained in a sale of those assets.  Having worked for the FDIC and being familiar with the credit quality standards being imposed on member banks, we asked the lender what he felt might be an appropriate amount to agree upon if he were to walk away from the credit.  After consultation with his colleagues, he informed us that he would accept approximately one half of what was owed.  With those marching orders, we sought out a lender that would consider the retention of jobs and the prospect of future success as a more compelling factor to lending than more standard criteria then in evidence.  We were able to secure most of the financing necessary from a quasi-public lender that had a much stronger public purpose in its charter and the balance was obtained be securing an equity loan on the home of the principal shareholders.

The result was the elimination of a crushing level of debt that was unsustainable and the insertion of a low interest source of capital that served as the catalyst for a more manageable cost structure.  In the process, the tax implication on the forgiveness of debt was offset from a tax perspective by the cumulative tax losses earlier sustained.  We were also able to secure a federal grant to support the sales initiatives contemplated at the onset of the engagement.  The business is currently debt free and looking forward to developing a strategy to transfer ownership to the next generation of the family.

 

Case Study: Sale of Losing Division and Replacement with Royalty Payments

A long standing client was faced with a dilemma of eliminating a “bleeding” division if it was to survive and support the operations of its profitable division.  After much soul searching, it was ultimately decided to sell the “loser” and concentrate on the “winner”.  A prospective buyer was identified and discussions began in earnest concerning its acquisition.  The problem was that the buyer needed to see the financial history in order to make an informed offer.  We informed the buyer that how well or badly this division had been managed, had no bearing on its value and in turn offered to share the customer list and the formulas that had formed the basis for the value of the business after certain confidentiality agreements had been executed.

The result was an offer that included only a royalty based set of payments on the sales of the products previously serviced by our client and a management contract for the owner.  The elimination of the expenses previously incurred by our client and their replacement with a stream of royalties served as the catalyst for a complete turnaround of our client.  The remaining division thrived and was ultimately sold to a major international player in the adhesives market at a substantial profit.  Three years later, the original buyer, who had realized substantial success in purchasing the business for a management contract and a stream of royalties and building a substantial international presence, called us for help with their banking relationship and the implementation of an acquisition strategy.  Nine years later, we continue to work with the acquiring company whose revenues are approaching $90 million.

Solving the Problem of Working Capital

Working Capital

A client approached us to request assistance in obtaining working capital in the form of a line of credit with its bank.  The lender and borrower knew each other well and the lender challenged the borrower to “match” the working capital it was asked to provide.

In the absence of additional capital investment, the client was unable to fulfill this “challenge” match.  We reviewed the balance sheet of the client and immediately observed that the accounts payable were substantially past their ordinary due dates and in fact, many vendors had shut off credit and were considering legal action to secure payment.  Total vendor debt was in excess of $400,000.  We began the process of identifying a solution which we refer to as the 1,2,3 plan.

All vendors were contacted and advised that the company could not bring its obligations current in any other manner than to pay the balance at the rate of 1% per month for the first 12 months, 2% per month for the second 12 months and 3% per month for the third twelve months and thereafter until the balance shall have been paid in full.  The overall repayment program would have consumed just under 47 months but full payment could be made which included a nominal rate of interest.  In exchange, the client pledged to make all future purchases on a COD basis until all past due balances had been paid in full.

The effect of this strategy was to give the client over $352,000 of working capital by switching a short term liability (accounts payable) to a long term liability in the form of a note payable.  The bank used the improvement in liquidity to make available a line of $350,000 secured by accounts receivable that were previously unencumbered by liens.  This line was used to meet operating needs and the COD commitment on future purchases with its vendors.  Payment terms were met, the company worked from a stronger balance sheet and profits improved commensurately.  The result was a win/win for all affected parties and a strong and loyal customer for the bank and the beginning of a long standing relationship with our client.