Preserving business value during the Economic Reckoning

We are living in a period of uncertainty, anxiety and loss of control. The last few weeks have seen unprecedented deterioration of wealth in the public markets. As investment bankers to the middle market, we anticipate that this period will be followed soon by a new, unprecedented time, a period of Economic Reckoning which will change the direction of many companies and the economic fate of their owners.

To preserve value, business owners must use prudent and swift strategies that will protect and enhance their companies. By understanding the nature and implications of this Economic Reckoning, there are direct and actionable steps that you, as a business owner, can take. These actions will determine:

• Which companies will prosper, and which will merely survive?
• Which once-profitable companies will not be able to overcome their economic challenges and will wither away?
• Which strategies and tactics can protect and enhance the value of your business?

Success or failure will depend on the willingness and ability of a business owner to adapt quickly to the new reality — business as usual is not an acceptable plan. Risk is opportunity: companies that take the necessary steps will not only survive but also prosper. Winners will gain new markets and greater market share as weaker companies fail or are acquired.

What are the tangible, actionable steps that business owners can take to preserve and enhance the long-term value of their businesses?

Liquidity management

Cash is the lifeblood needed to endure the Economic Reckoning. Many successful companies have stumbled by not having sufficient cash to survive short-term cash flow needs.

Identify your core business. Focus on segments that generate positive cash flow and direct resources to strengthen this part of the business, while preserving valuable assets for the future. Implement cost reduction initiatives and minimize non-essential variable expenses.

Manage costs vigorously during this time of crisis. Reductions in workforce, if needed, should be made swiftly and as deep as possible – this preserves cash and reduces workforce anxiety regarding further cuts.

Governmental programs to cover payroll should be accessed to the extent needed to retain go-forward employees. Divest non-core operations and sell non-core assets to generate cash. Direct investments should be consistent with the company’s strategic focus. To the extent possible, draw down on lines of credit to increase cash reserves.

Financial forecasting

Companies must stress-test financials for all potential downside scenarios. Scenario modeling should reflect customer demand, workforce resources and supply availability. Create a cash flow model. Although reliable accuracy is difficult to achieve, it is an absolute necessity during the Economic Reckoning. This type of forecasting will also allow you to better negotiate and receive more favorable terms from banks and other financing sources.

Business continuity planning

Identify key employees who have the capability of moving your business forward. Those who helped make you successful in the past may or may not have the vision to plot your future. Solicit input and buy-in from team members and other key employees. Anticipate and plan for operational disruption for at least the next six to nine months. Assess and protect your chain of business operations, focusing on the supply chain, cash collection and cash outflows, specifically AP and AR. Identify key advisors on whom you can rely to help you make the right decisions during this trying time.

Leadership

Crisis demands leadership. Leaders must be willing to adapt and think creatively to protect the business in the short-term and position it for success in the long-term. Leaders must project confidence, provide vision, establish teams, encourage collaboration, provide transparency and exhibit empathy. Above all, leaders must take early and decisive action to implement change.

Communication

Regular, transparent and visionary communication is vital. If you control the message, you can facilitate the adoption of the new strategy. Engage with all constituencies, including customers, clients, lenders, stockholders and employees. To emerge successfully from the Economic Reckoning you need the support of all these constituencies.

Employee relations and welfare

Move decisively to determine the go-forward team. Take all possible measures to protect and motivate the critical employees. Utilize outside resources, hold regular (virtual) meetings, solicit employee input, maintain personal contact with key reports and provide constant, transparent communication that both updates employees and conveys the company’s vision.

Customer and supplier relationship realignment

Reevaluate customer and supplier relationships to focus on the core business and protect cash flow. Renegotiate contracts to reflect the new reality and strategy of the company. Many suppliers will show additional flexibility at a time like this. Landlords do not want empty buildings; suppliers want to keep their plants busy. Don’t be afraid to ask for concessions as part of your long-term relationship. Monitor the financial health of customers and suppliers.

Optimize capital structure

In the Economic Reckoning, the cash needs of your company will change. Debt should be restructured to align with your new strategy, cash constraints and downside risk. Business owners may need to adjust their equity position to achieve these goals. Carefully manage lender relationships and negotiations in loan arrangements. Weigh with caution whether you want to increase personal risk such as personal guaranties. Communicate with your banks and financing sources. No one likes surprises. Present your requests as part of a plan that is well thought out and supports your requirements.

Outside resources

Take advantage of outside resources. These include government stimulus plans, SBA / SBI loans and tax deferments. These measures are short-term solutions that can help provide a buffer while implementing the company’s new strategy. Relying too heavily on outside resources is short-sighted and may mask problems that can be detrimental in the long-term. A combination of outside resources coupled with internal operational changes positions companies for long-term success.

Danger is opportunity

Early and decisive action will be rewarded in the short- to medium-term and preserve value in the long-term. Consider new vendor and customer strategies, alliances with vertical and horizontal partners and acquisition of weaker competitors. Survivors of the Economic Reckoning will have opportunities to grab market share and reimagine their business strategies.

We know that many middle market business owners are trying to understand whether the last month represents a loss of value that took many years of effort and sacrifice to achieve. Do not despair but do not delay — take the necessary steps to adapt and you can emerge from the Economic Reckoning as a survivor and well-placed to take advantage of the opportunities that will certainly be available.

Sheon Karol’s colleagues, Alan Scharfstein, Damir Makic and Milton Parra, assisted in this analysis.