In this article we provide a checklist to help portfolio companies in getting organised in addressing signs of financial distress. In the current situation a distinction should be made between portfolio companies which are hit directly -such as those in the travel, leisure and retail sectors- and those which are affected more indirectly and may have more time to adjust.
In this checklist we will focus on those companies which are clearly hit directly by the 'perfect storm' created by the Covid-19 outbreak and as a result run into immediate 'financial distress' and those that are likely to get into financial difficulty quite soon.
Typically private equity and venture capital sponsors have good systems in place to monitor and assess the financial performance of their portfolio companies on a regular basis. This tends to include their working capital, liquidity and cash flow. It is however important to recognise the rapid pace of the recent developments and the potential cascading effects which might follow. When the economic effects become more clear, it may well turn out that a portfolio company's projections do not appreciate the full scale of the impact of the pandemic sufficiently.
If an assessment reveals that a portfolio company is or will likely end up in dire straits, prompt attention to such company will be required. Reference is also made to "Crisis management: Weathering the storm".
A company in financial distress can only be effectively and successfully reorganised or restructured if it is clear what -apart from COVID-19- caused the financial distress. This is crucial for understanding what influence, quick fixes and tools management could have in the situation at hand.
A crisis like this rarely comes announced and crisis scenario's which are on the shelf are seldomly accurate or completely up-to-date. Typically a sudden event, especially of the sheer global size like with COVID-19, is characterised by a sense of chaos, confusion and crisis. The first thing a company and its stakeholders need to do is to get organised, and to get organised as soon as possible by setting up appropriate crisis teams and communication structures.
Two particular items to be assessed quickly by a crisis team in the current situation are the eligibility and steps to be taken under the various facilities made available by the European and Dutch governments and to monitor the developments thereof closely:
Apart from COVID-19 specifics, a financially distressed company in its getting organised, should focus immediately on getting clarity regarding the following areas in particular:
- Asses likely causes -besides COVID-19- and the options and any quick fixes open to the company still;
- Identify quick wins in respect of cost cutting and working capital improvements;
- Identify the company's stakeholders and their objectives and restraints;
- Review the key commercial agreements, including insurance policies, click here for tips;
- Review the finance documents;
- Get a clear view on the company's corporate and capital structure;
- Determine a first idea 'where the value will possibly break' in the capital structure; and
- Get a picture of personal liability risks and where the legal and practical boundaries are.
Although this might appear somewhat premature if formal insolvency proceedings are not currently expected, it is good at this stage nevertheless to determine which insolvency regime would apply. This is important because stakeholders will often base their negotiating stance in a consensual restructuring on what their position would be in insolvency proceedings (which is generally seen as the worst case scenario).
Further guidance on developments relevant for private equity and venture capital portfolio companies will follow in our next posts.
NautaDutilh prepared a course on restructuring (in Dutch) at the request of the Dutch Private Equity and Venture Capital Association (the 'NVP'). More information can be found here. The dates, times, format and location of the course are subject to change in view of the ongoing developments.
We are in consultation with the NVP regarding the possibilities to present modules of the course, that are of particular relevance in the current environment, in a different format than originally planned. More information will follow as soon as possible.