Restructuring a label-making business to survive the economic crisis
A label-making business operates within the food processing sector, as a supplier for food producers. In the past, the business was heavily dependent on one of its key customers. This specific customer was a large producer of food products and was responsible for about a third of all revenues. When the global economic crisis hit, it affected both the business and its biggest customers.
The business had revolving credit facilities with three banks. Each of these credit lines was unsecured and freely available for general business purposes. Interest was payable on drawn amounts and the revolving credit facilities were all fully drawn.
During the crisis, the business experienced a sharp downturn. Business was slowing down for most of its customers so they needed fewer labels. The business’s biggest customer cancelled all orders until further notice, and the business was experiencing significant cash flow problems. Its credit lines were all due to mature within three months at which point the business would be required to repay these in full.
Because of the crisis, the business was not generating the positive cash flows needed to either repay its bank loans or seek a refinancing. It also needed some extra financing to make urgent changes to its operating model in order to achieve turnaround of its performance.
The business was able to notice and react quickly to the downturn in its performance since it had built up a solid financial reporting system including early warning signals. An important early warning signal was its solvency ratios, in particular, its debt-to-assets ratio. Since the crisis had started, the business’s debt-to-assets ratio had increased significantly, meaning that it was funding most of its operations with debt rather than assets and would not be able to meet its debt repayment obligations.
The management tried to set up a FOPIP (financial and operational performance improvement programme) plan, but the economic downturn was too sharp and they realised they had already passed the FOPIP stage. They needed to do more substantial financial restructuring, including turnaround and reorganisation of their business.
As soon as management realised that they were no longer operating successfully and were losing money, they informed the business’s owners about the financial difficulties. They then initiated an IBR (independent business review: the initial step in the financial restructuring process) to identify the most problematic areas of the business and possible solutions.
On the basis of this IBR, management prepared an action plan for the business. As the business was mainly struggling with cash flow and making payments, the priority was to stabilise cash flow and establish good and sustainable cash flow management. The plan included the business requesting a restructuring of its existing credit facilities with the banks, as well as a new loan. It also planned to apply to government bodies for time extensions on payment of tax and social security contributions.
Soon after presenting the action plan, management initiated the restructuring process and contacted the three banks which were its major creditors. Management considered contacting the business’s suppliers as well, but did not want to scare them off and potentially destabilise the business. As an alternative, management looked carefully at the supply contracts and asked for an extension of eight weeks in payment terms from key suppliers.
At the meeting with the banks, management explained that the business needed to defer repayment of the revolving credit facilities which were all due to expire within the next three months. They also asked for a new loan since the business’s revolving credit facilities were fully drawn and they needed additional liquidity to support the business’s operational restructuring.
As there were a number of creditors, one of the banks suggested that they try to follow the INSOL principles. The business then tried to sign a standstill agreement with the banks to give it the more stable platform it needed to negotiate the restructuring. As part of the restructuring, the banks requested the business to provide security. As the business did not own the factory from which it operated, its main assets were its inventory. The banks also requested a personal guarantee from the business owner and higher fees and margin on the credit facilities, as well as a tighter covenant structure to monitor the business’s performance and operations more closely.
Unfortunately, one of the banks decided to withdraw from the restructuring negotiations and refused to sign the standstill agreement. This bank put the business on notice that it did not intend to extend the term of its revolving credit facility, which meant that the business had repay this in full in only two months. This made the business’s financial position unsustainable as the two other banks refused to agree to a restructuring without the participation and agreement of the third bank. The management decided that they had no other choice but to file for insolvency.
As management believed the business was still viable they applied to court for the opening of reorganisation proceedings, with the assistance of a lawyer, to try to restructure the business’s financial position and ensure its continuation. By using these proceedings they hoped to reach a court-imposed agreement with their majority creditors, which would force the dissenting bank to agree to the terms of a general restructuring, including the extension in the term of the revolving credit facilities. While management would be able to stay in place, the court would appoint an administrator to help supervise the running of the business. The administrator would report his observations back to the court every two weeks.
The business presented its reorganisation plan to court. Mostly the plan dealt with restructuring of the business’s debts. Fortunately, a majority of creditors voted in favour of the plan and it met all other legal requirements, so it was approved by the court and became binding on all creditors. The business was then required to implement the approved plan.
After the success of the reorganisation proceedings, the business decided to make additional changes to improve the efficiency and profitability of its operations. It invested a lot of effort and finance into creating and implementing a diversification strategy. The strategy included diversification of its customer base and portfolio to avoid the situation recurring.