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Read MoreIndustries are slowly reopening after an unwanted hiatus due to the pandemic. Healthy companies are facing liquidity risks; business plans prepared for Q4 2019 and Q1 2020 are obsolete. Companies that were having issues prior to COVID are in survival mode and may be losing the battle. To help preserve borrowers’ liquidity, we have seen lenders step up and provide a moratorium on principal and/or interest payments, and landlords have also deferred payments. Companies have drawn down on their revolvers, secured loans against unencumbered assets, and received PPP funds. Hopefully, companies have been focused on reducing their break-even by executing on plans to consolidate plants, eliminating capital expenditures without an appropriate funding source, and starting with the C-suite, implementing salary reductions, furloughs, and a hiring freeze.
It is already June, and Q2 is almost in the books. There is a high probability that companies will bust covenants at the end of the quarter and default on their lending agreements. Too many companies are not preparing for these events. They may eventually ask for a three-to-six-month forbearance agreement, further moratoriums on their debt payments, and out-of-formula loans.
The lenders will then be in an unreasonable position of having to make decisions without the requisite data. Further, even if the company provides some level of forecasting, is it reliable? First, middle market companies are generally not very good at providing realistic forecasts, and second, many management teams prepare the numbers assuming everything will go well without any downside risk. The result is an obvious and complete waste of time. Savvy managements will hire financial advisors to lead the process, but the other 98% will require a strong push.
Financial Advisors (FAs) can remove the clouds and present a clear picture on the horizon. The sooner a clear road map can be prepared, the sooner parties can make decisions on next steps. Issues surrounding “base case” short-term cash flow and borrowing base availability, collateral values, enterprise value, EBITDA, and long-term viability are among the hot topics to be addressed immediately. Once the base case is understood, performance improvement enhancements can be identified to improve upon it. Not all companies are created equal, so storylines range from the good to the bad to the ugly. Regardless of the final storyline, the important thing is to determine where the company fits so business decisions can be made. It does not make sense for a lender to allocate a high percentage of their time to a company that is either non-viable or no longer fits the bank’s lending profile.
On the flip side, time is not a friend to a wavering middle-market enterprise, so it is best to understand this as soon as possible before realistic options begin to dry up. The warning signs of a company in trouble are not difficult to see. Examples include growing past due payables, shrinking availability on the line of credit, tighter credit terms from suppliers, a looming debt maturity on the horizon without a plan to refinance it, poor quality and growing chargebacks from customers, old equipment without means of replacement, etc. All these examples are often predominant at the company long before a loan covenant is breached. These issues are not foreign to company management, but rather than fix the problems, many react by hoping the economy improves, revenue follows, and they sell their way to better days. Unfortunately, this almost never happens.
The bankruptcy process offers a variety of tools helpful to the debtor, including the automatic stay, rejection of agreements, and more. However, it is also expensive, time-consuming, and stressful for ownership and management. Further, many middle market bankruptcies result in asset sales and/or liquidations, with ownership walking away with nothing, and they may have to make good on personal guarantees. Most middle market companies need debt restructuring done economically and quickly. [1] A viable alternative to a federal bankruptcy filing is an out-of-court workout in which unsecured debt is frozen as a note payable and set aside in an unsecured creditors' pool. The term of the plan (typically three to five years) would require utilizing a percentage of free cash flow (NI – debt service-capital expenditures) to provide pro rata distributions to unsecured creditors twice a year. Any unpaid balance at the end of the term would be forgiven. It would be critical for business owners to seek help from a financial advisor to provide not only the skills to develop the plan but also the credibility needed to gain buy-in from creditors.
Disruption often brings opportunity. Those companies that embrace it will adjust their operations and expectations in the near term and ready themselves for bigger and better opportunities down the road. Conversely, those that are less than enthusiastic may find themselves on the wrong side of momentum, declining enterprise value, and fewer options to restructure, perhaps even running for cover in bankruptcy. It is true that the bankruptcy process offers a variety of tools helpful to the debtor (automatic stay, rejection of unfavorable agreements, etc.). However, the bankruptcy process may not yield the results shareholders prefer (not to mention the process is expensive, time-consuming, and stressful). Most middle-market bankruptcy filings do not result in confirmed plans but rather in a combination of 363(b) asset sales and liquidations. As a result, secured and more likely unsecured creditors may be significantly impaired; ownership typically walks away with nothing and may have to make good on their personal guarantees. For companies with a viable core enterprise but too much debt, an alternative to the federal bankruptcy process is an out-of-court workout in which unsecured debt is frozen as a note payable and set aside in an unsecured creditors' pool. [1] For example, the plan term (three to five-year time horizon) would require using a percentage of free cash flow to facilitate pro rata distributions to unsecured creditors twice a year. Any unpaid balance at the end of the plan would be forgiven. For this to occur, the unsecured creditors would need to receive more than they would in a liquidation, taking into account the time value of money. In this instance, the debtor would certainly require outside legal and financial help to craft and execute a plan and gain much-needed credibility from creditors.
We would like to thank our colleague Michael Boudreau for providing insights and expertise that greatly assisted this research.
Michael Boudreau, CPA, CTP, CFF, is a Director in J.S. Held’s Strategic Advisory Group, having joined J.S. Held in July of 2025 as part of J.S. Held's acquisition of MorrisAnderson. Mike has over 25 years of experience in restructuring, turnaround, and valuation services, guiding companies through bankruptcy proceedings, including Debtor in Possession processes and Section 363(b) sales, and serving as a court-appointed Receiver and Assignee for the Benefit of Creditors. His expertise includes business planning, financial forecasting, and cash flow management across industries such as manufacturing, construction, real estate, retail, aerospace, and healthcare.
Mike can be reached at [email protected] or +1 248 227 0978.
For further discussion on this topic, see the March issue of CFO Magazine authored by Dan Dooley (J.S. Held) and Sheryl Toby Dykema (Gossett PLLC).
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