How to Execute Distressed M&A

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How are you doing Today I'm doing fantastic.

We're here live in New York City. Thanks for hosting at your headquarters.

Of course. We have beautiful views and I'm glad to be here.

Can we kick things off a little bit about your background?

I graduated from Columbia in 2015 with the JD MBA. I summered here at Sullivan and Cromwell and have been here ever since. So now I'm a partner at SNC in what we call our general practice group, which is our corporate group specializing in murders and acquisitions of all sorts. So I do a lot of traditional M and A public private, whole company sales, joint ventures, minority investments, basically the whole gamut. But one of the things I do specialize in is distressed M and A. So I've done a number of deals in the distressed space and we have what we call primaries and secondaries for our associates. So my secondary was restructuring. That basically just means I get parachuted in whenever we've got a Chapter 11 case and they need something sold.

That's a long time in a law firm. That's a lot of deals you've touched.

Yeah, we're a unique law firm in that a lot of people start here and stay their entire careers here. So I'm only 10 years in, but looking forward to the next however long.

When you say distressed and restructuring, are they the same thing or do you look at them differently? Is distress is an umbrella term? Restructuring gets more specific.

We tend to use it fairly interchangeably. But you're right, there is a slight difference. We might have clients that are generally in financial distress and they have a number of options that are open to them. Chapter 11 restructuring, which is a court mandated process, is something that is more specific and it's one of the avenues they have to reorganize the business. But they could do it outside of restructuring. They could do it by getting forbearance from their lenders. They could do it by just selling assets. Typically when you get to a certain level of distress or you're looking for those court tools that we'll talk about today, you will actually go in for a court filing. It's an expensive process and it's one that will take many months into, potentially years. But it's one that is very powerful, certainly one that a lot of companies see as a tool in their arsenal when they're facing a distress situation.

The chapter 11 is basically the main tool you would use to restructure the business and get in a different place. Yes, I'm familiar with the 363asset sale because I've worked on a handful of those deals. Where does that fit in the picture?

So 363 refers to section 363 of the Bankruptcy Code which governs the use of a debtor's assets outside of the ordinary course, including the sale of all or substantially all of a debtor's assets. Typically, a company might look at a 363 sale when they have a going concern business or they have assets that they can monetize. And they want to do that either at the outset of the case or earlier in the case than it might take to be able to reorganize everything else. So the 363 process is a public process, but it is a sale of assets when you get into bankruptcy so that you can push those assets off, let them continue as a going concerned business in somebody else's hands, and then figure out how to deal with all of the creditors that are left behind.

Interesting is that the main way to sell during a Bankruptcy is a 363asset sale.

It is one of a couple of ways to reorganize. It's a very common way to sell again because often it will take longer to be able to organize all of your creditors into a plan of reorganization. But you could also sell as part of a plan, as part of a prepackaged plan. So you already have an arrangement ready to go with your creditors and you kind of have a sale as part of that. Or in many circumstances debt holders can decide that they want to equitize and you can use chapter 11 to hand over the reins to debt holders. The debt holders will convert into equity and continue to run the business. So there are a number of different flavors. But 363 sales are very common.

This got complicated quickly. So we have some different flavors of this 363 sale would be selling the asset without any debt attachments.

Yes. And it's broader than that. So 363 one of the most valuable things about a 363 sale is that the assets get sold and blessed by the court in a sale order as free and clear of all interests. And that's interpreted very broadly. So it's free and free and clear of claims, liens, attachments, but even historical liabilities. A buyer typically loves 363 as a way of getting assets because they are able to take the assets without not just the debt that encumbers the overall business, but they can also skinny the business and go through the contracts. Leave behind or reject certain contracts such as significant leases that are impairing the value of the business. And they also can leave behind things like historic liabilities when they take forward the going concerned business.

And then if you sell, do a sale that includes debt that wouldn't fall into 363.

Typically you don't do a sale that includes debt. Typically a buyer wants to come in and just take an operating business and they can lever it up or introduce whatever capital structure they typically have with the rest of their business. But they would leave behind the historic liabilities and the historic debt.

And then you have this other area you mentioned where debt can turn into equity.

Debt can turn into equity. Yeah. Sometimes you have creditors who just say I can run this business better and they're willing to hold on to a business. And sometimes this evolves. You might go through a sales process, determine that it's not a good time in the market and the debt holders might say I can run this business for a couple of years, turn it around and then sell it. You see that happen occasionally too.

Maybe okay, we jumped into this. Now let's, let's go back out and maybe just broadly explain why do companies get into these situations that they would leverage at chapter 11?

Often there's something wrong with their capital structure. They've either taken on too much debt or it might just be operating liabilities. So there have been a number of retail bankruptcies in past years where there are significant lease obligations that might be outsized for the scope of the business as it currently exists, or they might just have a deteriorating business. I've worked on deals like LSC Communications, which was one of America's largest print magazine and book publishers. And it's just a business where they had a lot of debt and the business itself was shrinking so they needed to right size it in some way.

They basically can't pay their debt. And there's different business factors and why they couldn't do that, that something impacted their business where operationally they're not making the money to pay their debt.

Yes, that's typically how it happens. I mean you also see situations like FTX where there's just an insolvency crisis and you need a way to stabilize the business. The other real value of chapter 11 is the minute you file papers to go into court, something called the automatic stay comes down which prevents pre petition creditors from going after the assets of the business, filing new lawsuits or otherwise interfering with the operations of the business. So that's really powerful. You can't have dozens of people trying to claim on properties and claim that you're in default and it allows you time to go through and figure out what is the right capital structure, what is the right way to operate. And anything that's pre petition is just halted but just creates that breathing space that sometimes a company needs. Especially in a situation where there might be external financial factors where they can sit and figure out what makes sense for the actual underlying.

Business can't pay debt. Some fraud and other crazy stuff happen to be the other situation. Do you work on ftx?

I did work on ftx.

That must have been a lot of fun.

It was a lot of fun. I would say it is not the usual sort of M and a sale. Typically after you file for chapter 11 the existing board and management would become what's called the debtor owned possession. They would continue to run the company. Of course that didn't happen with ftx. So new board goes in, new management goes in and then we come in and have to dig through and figure out do you actually own the things that you think you own? And what about these other 200 assets that nobody knew that you owned? So it's hard to sell something without knowing what it is.

Wow, that's interesting. So we have this situation comes up. How does the process start? Do you contact an attorney and say hey, we need to file chapter 11 or do you raise a flag to the bank? What does that look like?

Usually you know it's coming well in advance. There are situations of course, like FTX and Sullivan and Cromwell also worked on the Silicon Valley bankruptcy. There are situations where all of a sudden you wake up, you're in a liquidity crunch and things have gone wrong and you're panickedly calling your lawyers and getting financial advisors. But much more of the time something has to happen. You know that you have debt defaults coming or that the credit environment is deteriorating. You will have bankers lined up and attorneys lined up to prepare Chapter 11 papers while you might be parallel tracking a sale or a workaround or forbearance agreement with your creditors. So. So you might be going through a couple of different processes to see if you can get leverage against your creditors. And then you might be working on bankruptcy papers in the background to force the hand or as a rescue situation if things don't work out with the creditors outside of bankruptcy.

The CFO approaches you with this chart going down into the right, it's below the black turning red. And then at that point you start talking to your creditors. And then you mentioned knowing the bankruptcy process is there. Is that something you talk to your attorney and they start planning with you or what's that process?

Yeah, I mean it's certainly something that you often, if you have the time, you would plan out with your attorneys, with your financial advisor. Sometimes, you know, you have to right size the debt in some way. You want to do it through a chapter 11 to get certain other creditors on board and you'll be package something so you'll have a bankruptcy that is largely arranged with a couple of your constituent creditor groups already on board and that you can use the Chapter 11 process to shed certain debts, shed certain liabilities and then get out within a couple of months. And then on the complete other side of the spectrum, of course you have things like ftx which is a free fall and will take years to be able to reorganize.

We'll use that as an extreme edge case. Focus a little bit more on what typically happens. These two actually do happen. It sounds like the first thing is try to negotiate the creditors directly. That seems like the most logical thing to do.

Yeah, it's rare that again you don't see it coming. And often you would go to your creditors and see if there's something that you can work out. Some sort of forbearance you can work out.

What does forbearance mean?

It just means that they're giving you a waiver and you don't have to pay your debt now. You can pay it in back stays. Yeah, they give you a little bit.

Of leeway or you could potentially renegotiate terms that happen.

Yeah. Hey, it's all on the table.

Not going to like it. But there is no standard playbook. This really depends on who your creditor is. You could have a nice creditor, you could have a not so nice creditor.

Yeah, absolutely. One of the most fun things about being in that distress situation is it is always unique. And I know we say that about M and A more generally. Every deal is unique, but really when you get into distress, you have so many creditor groups that you're listening to, you're thinking about so many different paths. And again, you have a lot more powerful tools that you can use. But there are drawbacks that come with all of them.

My first tool is just negotiating, negotiating. And then they get not so nice creditor and negotiating is not working. They're like, we want our money, we're not giving you any breaks.

I mean, depending on the credit environment, you could seek to raise additional capital. In the early Covid days we saw a lot of companies looking at pipes, private investments, in public equity. So public companies seeking additional investments in order to bolster their credit situation, you see that now as well. So that's another situation. You could try to raise money, you could try to do other asset sales. So sell parts of the business to raise money. But that assumes that you have enough time to be able to actually go to market and that whoever you're negotiating against doesn't think it's a fire sale situation. Try to take advantage of you.

So we got some good options already. These are non bankruptcy options. Negotiate with the creditors, raise additional capital or sell part of the business and then may say it's a tough market and it's hard to raise additional capital and we don't have really interested buyers given the timeline we're dealing with. And we file bankruptcy, I call you say mimi, I think we need to talk. Bankruptcy is a tool to use and it basically gives you some protection from the creditors.

Yes. So you file your Chapter 11 petition papers and then again the automatic stay comes down and you are basically protected. You have a window of time where you can collect yourself. Nobody can file to foreclose on any of your properties. Nobody can file additional lawsuits against you. They all have to go through the court process. And you have time to assess and plan out potentially a whole company sale procedure which would be the 363 sale.

Does that usually happen? A 363 is going to be a sale of the entire company and then they just pay off the creditors with the money proceeds.

So it depends on the company. Often it's a sale of substantially all of the assets. So yes, a whole company sale. But the bankers will often advise, maybe you could look at segment sales as well. Maybe this is a company that makes sense if it's actually broken up. So you have the ability to sell some assets or segments of the business separately or the whole company.

How do you determine that?

Usually a financial advisor will launch a process and they'll market different assets. If the assets aren't substantially related to each other, maybe it makes sense to have different buyers buy different pieces of the the pie.

So there's a business case to split up the assets of. Hey, this is actually going to make more financial sense. Okay.

And they're going to be marketing potentially the entire business. So they'll see what bids come in and maybe it makes more sense. People are bidding on two different pieces and they'll offer more versus for the whole company. So they'll also be able to see at the end what value they get.

When we file chapter 11 this buys us some time. These creditors can't keep coming after us file. If they file lawsuits, they got to go through the court system. How much time does it buy us?

Typically, I think exclusivity expires 180 days after you file. And that's exclusivity to file the plan of reorganization. But look, people are going to want to move more quickly to figure out what's the plan for the case and how do you reorganize because you are still sitting on a business that presumably is deteriorating in some way. It's not great for employee morale that you're now in chapter 11. Often you will look at, can this company continue under new management in some version of its current form? And you might start the sale process much earlier.

Does filing chapter 11 then give me more leverage to negotiate with my creditors?

It often does because you have again, a number of tools to reorganize. But all of your creditors now have a say. Once you're in the zone of insolvency, the debtor has the obligation and the fiduciary duty to maximize value for all creditors. And once you're trying to sell all or substantially all the assets, they're required to try to receive the highest and best bid. They have to give all creditors notice and opportunity to be heard. All creditors now have to be considered. Yes, you have leverage over your secured creditors or your debt holders, but now you're also dealing with other stakeholders. You're dealing with employees, you're dealing with contract counterparties. And so everybody kind of emerges from the woodwork.

This is where you're teaching me the Trump playbook and how to use restructuring as a means to create some value. You create a plan to reorganize and you're basically part of it. Could be restructuring your debt with the creditors because you're trying to preserve value of the company. You're trying to avoid a 363 sale unless you're in a situation where you just don't care.

So again, it depends. So there are certain situations where that the creditor doesn't necessarily want to buy the business or they have the opportunity to actually buy. They can credit bid. If they have secured debt, they can credit bid that debt and say that value of the secured debt is the value I'm putting into an auction. But then you also have other people coming in and giving you actual cash. The creditor might like that better, but the value of the 363 sale is you can do it quickly. You can put up the bid Procedures. You have a public auction, you can sell off all of those assets and then people fight over the pie that's left. Or there could be a large historic liability that you're trying to leave behind that a buyer doesn't want to take. And you can figure out what to do with that liability while you're dealing with the rest of your creditors.

It's complicated. It depends on the credit card. Basically, at the end of the day, how much cash they want. Because they could say, hey, If I get 50 cent, and then seeing what that's what's going to happen, the sale, I'll be happy. Otherwise.

Otherwise, yeah, they might take over the business.

At that point, they said, hey, the value of this is, I see more value. I'm going to just put the bid on the business to make sure we preserve our bottom line. And then they take over the business. Then do they usually plan on operating the business or their intention is to hold it and sell it?

Often there are distressed hedge funds or others who don't want to hold it long term. Most of the time, your creditors aren't strategics. There'll be some sort of financial player that would hold the company for a short period of time, turn it around and then sell it again.

Where does that determination come from? If I'm planning this reorg and then creditors aren't buying it, they're like, no, we want to get more value than where you're offering the 10 cents on a dollar. Then what happens? Does it get to that point when you're presenting in front of a judge and they're like, we're going to have to sell this business and just get what we can for it and sell it.

A lot of the time the creditors don't mind the market check. So you would go in at the beginning and say, I have bidding procedures. This will guide how I'm going to run and tell everybody publicly how I'm going to run this sale. You have to put your indications of interest in at a certain date to put in a qualified bid at a certain date. And then you have done a market check, what the value of the business is in the market. Plus you have auction procedures which hopefully will drive that value up. And then at that point, you don't have to sell. If there is a more value maximizing approach that one of the creditors can propose, you might flip to that approach. None of this obligates you to sell if you launch the auction process, but it gives you a good sense of what the business is worth. And again, there's often some value to selling early because it preserves a going, concerned business away from the liabilities that exist and away from all of the infighting with creditors.

Very interesting. So during this process, when I want to determine this market check the market value, would I retain a banker?

Yes. Yeah, you would retain a banker.

Are these usually bankers that specialize in this situation or are they just general bankers?

A lot of them are boutique shops, but they're the same places that typically have an M and A team. So they'll often have restructuring team and an M and A team. Places like Guggenheim, Evercore, all of them. Parella. They all have teams that do this.

Okay.

But they'll bring on their M and A folks to sell the business.

And they're used to it. They'll have their group restructuring group and they may work with like industrial focused group as well. They bring this business out to our interested buyers, get some preliminary indicator of interest. And then you mentioned like a qualified bid.

Yeah. So usually the way that the bid procedures work are you'll have a couple of different stages after the indications of interest. It's just like a typical M and auction. Then you'll provide a purchase agreement and true diligence. And you say by this date you have to provide a qualified bid. You have to put in. In bankruptcy, it's a little bit different in that you have to put in a deposit upfront. So pay to play. You're a true party that's looking to buy this. Put in a deposit upfront, you'd put in all of the papers and you'd say, yes, I'm ready and willing to come to the auction. And then you might have, hopefully the idea is you'd have multiple bidders and then you'd be off to an actual auction. That tends to create significant value.

Does the winning bid usually win or is it principals come back and say, no, we're going to keep this business somehow.

So usually the winning bid does win because you've done a full market check. The creditors have had the opportunity to observe the entire process. Everybody does. It's a public process.

And the creditors could have bid too.

And the creditors could have bid too. And if they didn't come up with a bid, or if they put in a bid that was lower, then they should be happy that they're selling at a better price.

What are the key differences between going through the sale process versus a traditional M and A process?

One of the big differences is the publicity of the process. The debtor is trying to achieve the highest and Best offer. The bid procedures are public. Bankers will reach out to a number of people in the process. And then at the very end, once you actually have qualified bids, hopefully you have a couple of them, you will bring them to a banker's offices or law firm offices, put them in different rooms, try to get them on a similar contract, and then say, all right, let's make this a true auction. So it's like a Sotheby style auction of 100 million, 105 million, 110 million going around. And then you can find what is the actual top limit somebody is willing to pay for the business.

Wait, they actually do that? They actually get people in a room.

That's the most Fun Part of a 363 sale is you've got people in rooms and then you'll bring them together and they'll actually say, this is my next bid.

You see this other be like the ego.

You have people, you go down the line and you say, okay, you can skip once, but otherwise you have to put in a bid or you're out. And then you might actually go down the line and say, all right, this person's bid this amount, this person's bid this amount.

And then somebody will come back and bid higher.

So as a buyer, you better come prepared with your checkbook.

Yeah, I was hoping to learn how I could get a good deal in action. I don't know. This is the exact situation I'm trying to avoid.

Mimi, what if you're a debtor, you're trying to maximize value and that debtor.

Yes.

Truly maximizes value.

I'm a buyer. I'm on the buy side and not helping me out here. I thought I was going to learn how to find great deals in bankruptcy auctions. Okay, we'll get to that part. We'll get to that part. Wow. So they really. You'll find bids and you get to that point when you'll create like a real auction environment.

That's the goal. It doesn't always work out that way. Maybe the market is softer, maybe you just can't get bidders there. Or maybe your bids are just so different that it's hard to compare them. But the goal of running this auction is to try to get everybody to like a very similar bid so that you can run that sort of auction. Because it tends to be a place where people start bidding up and giving you value.

I would love to stream this, actually. If I could get the opportunity just to stream this happening would be different.

Jurisdictions do it differently. But I think Delaware requires Most auctions to be streamed or if you're a creditor of a bankrupt business, you're allowed in the room. So you can just be sitting there watching.

Great to know. Yeah, that'll be my new hobby to start live streaming on YouTube and then is there anything recourse if they put a high bid in, then don't execute on it.

So deal certainty is something that you're going to put a high premium on when you do these sorts of deals, but it's going to really be on the financial advisor and the lawyers to craft as exit proof a deal as possible. So think of almost like a public M and a deal where you want as few outs as possible. You're going to want even more of those in bankruptcy. The real out is if you get a topping bid, the debtor is going to want out of the contract and they're going to have a fiduciary duty to get out of the contract. But otherwise, typically as advisors, you would advise the board to take a deal that is much more certain.

What's the aftermath in terms of leftover liabilities and things like that? I can imagine this list of creditors and how do you determine who's got priority seniority and what do you do with leftovers?

So in the 363 sale, you're taking the assets. The buyer is buying the assets free and clear of liens, claims, encumbrances and other interests. And all of those then attach in the same priority to the proceeds of the sale. So imagine all of the assets and the employees and the operating business go away. You're left with a pool of cash and then the creditors would be fighting over that pool of cash in the same way they would otherwise be fighting over it. So if you're a secured creditor, you're going to have a better claim than certain unsecured creditors. All of that will still actually just be preserved. The structure, the credit structure will be preserved and they'll just attach to the pool of proceeds instead.

Unsecured creditors ever get anything?

Yeah, they sometimes get things back in FTX they're actually getting. They're supposed to be getting their entire proceeds back.

Very good. Okay, so they planned this ahead of time. Who's getting what? Is it like a percentage or is it.

There's a waterfall again, just based on the actual priority of claims. So there'll be some things that are mandated by the statute that'll be super priority claims or administrative claims, often claims that are amounts that are paid post petition to maintain the business. Or for advisors, those get priority and then you've got your usual secured claims and then after that you've got your unsecured. So it's the same waterfall that you would statutorily have.

If we have the sale process happen, high spitter wins, proceeds are already laid out of, the creditors are going to pay off and then they get their money at close basically and then it's done, everything's over with.

They get their money as part of the plan of reorganization. But yes. So that gets to be negotiated afterwards and sometimes it could take months and months for them to negotiate how much of a haircut each group of creditors is willing to take or how much, how exactly that pot of proceeds will be divvied up. But. But yeah, that's done. And for the employees in the actual operating business, it's done well ahead of that argument. It's a pretty good deal for them.

So if I get a customer that goes bankrupt and I get all these bankruptcy notices from the attorney, what should I be doing?

You should call your own lawyers to figure out what you can do. So one of the other powerful tools that a company has a debtor has in bankruptcy is the ability to assume or reject contracts. So they can look at their contracts and they can say these contracts I want to keep performing and are valuable to me. I'm going to assume them. And then they have to cure all of the pre petition debt. So they have to bring it basically up to current. But then they can also take a look at contracts and say this lease is huge, I don't want it, I want a way to basically resolve it. And they can reject the contract. It's almost like a way of liquidating the damages if you had breached the contract. So you get out of the contract the expectation damages under the contract are now unsecured claims that are against the estate and you can leave that behind. So you can right size the company that way if you're a vendor, you have to be cognizant. That is a possibility. You might have your lawyers reach out and figure out what's happening with the contracts. But the debtor has a lot of control there and the buyer has a lot of control there. Because the buyer can say I want these contracts, I don't want these contracts. I no longer need this shopping center, I no longer need this vendor contract. I'm going to adjust X, Y and Z and they can have a much better business going forward.

Interesting. Do you have a case study or example you could share of, like how this pans out in the real world.

Earlier this year, I worked on the sale of Kita Fenwall. So kitifinwal is a subsidiary of a company called Carrier, and it had significant PFAS liabilities, which are forever chemicals. They had significant lawsuits from a number of states because of forever chemicals that were used in the business over a decade ago. But of course, those last in the environment, and we're seeing a lot of lawsuits there. And bankruptcy was one way to potentially deal with the liabilities while preserving two ongoing businesses. So Carrier sold the assets of Kita Fenwol out of bankruptcy, and it was a fairly protracted process. Sale process was launched about a year and a half ago. It might have been September or October of last year, after there was a basic agreement about how to treat the proceeds, which is the proceeds would go towards covering these environmental liabilities. Engaged bankers did an entire sale process, ended up selling to a company called Pacific Capital, which is private equity company. The business is ongoing and they're managing it separately. And then the amounts that was left is part of a pool in addition to amounts that Carrier is going to contribute as part of a broader settlement for this huge litigation. So it allowed Carrier to extricate itself both from the business, but. And it allowed the Kit of Enwal business to extricate itself from this environmental liability under new management.

That's, like, pretty well played there.

Yeah. But the settlement took six, eight months longer than the sale process did. So it was great that the sale happened early because it allowed the company to continue to operate without this overhang.

Right. We didn't talk about that. Like, lawsuits could be a reason to trigger a bankruptcy.

Large litigations. Exactly.

Yeah. What was the one? The one in the news?

Oh, Alex Jones. Yeah. Infowars.

Infowars. Infowars would be an example of.

Yeah. Shedding lawsuits. It was a partly. I can't remember if it was a personal bankruptcy, but certainly infowars went through bankruptcy as well. And it was the libel suits that they were trying to get away from. Right.

And then the victims won, I guess.

Like, literally as they should.

That's really interesting. I guess that's a whole other thing. It can take someone down with a bunch of lawsuits and push them into bankruptcy, then buy their business. When it comes to the different types of creditors we talked about, secured versus unsecured, are there other factors that would determine how much influence creditors have during bankruptcy?

So typically, and this is something that you find out very early in a case, there's something that we call a Fulcrum Creditor so oftentimes, even the secured creditors, there's a waterfall of those secured creditors. So some of them are secured or over secured. They know they're going to be paid in full. You don't really deal with them as much. There are sometimes with the unsecured, they'll have a committee that represents them and makes sure that their interests are heard. But often they're pretty far underwater and certainly any equity as well underwater. There tend to be what are called fulcrum creditors and those are the ones that kind of swing things. So they're the ones that tend to drive the case because how much they're paid out really depends on how much value is able to be recovered by going down a sale process versus a reorganization process. The creditors have different ways to be heard, but it is often that fulcrum creditor group that really drives the case forward. Again, in connection with certain other groups that are formed or statutorily have to be formed, like the unsecured creditors committee.

There'S a main group that sort of lobby together.

There is a main group of creditors that lobby together and that tend to have significant influence on how the case unfolds. And then the unsecured creditors will have a committee that's formed by statute so that they can make sure that they have interests heard and different creditors get onto that committee. So it might be customers, different types of vendors, landlords. And they will also see everything in the case, be given copies of all of the notices and be able to help drive the case forward even if their recoveries might be minimal.

What's my best approach in negotiating with these creditors?

Depends on the case. It's really hard to say. It really depends on the dynamics and sometimes it just takes a long time to sort through how much value each of the groups is going to get.

Say, I guess it wouldn't be too hard to find who to talk to. Like they would pretty much be knocking on your door.

Oh yeah.

Is there any approaches or just things have you seen that might be best practices when dealing with creditors? That is like don't avoid them at all costs type of stuff.

I don't think you're allowed to avoid them. You're in a court process even beforehand. They can come knocking once.

He always notices.

Don't hide from your creditors. They can always find you. They can throw you into bankruptcy as well. It's much more unusual in a big corporate context, but they have the ability to force an involuntary restructuring. You need a certain number of creditors to file, but then if they get that number to file, they can force you into bankruptcy. You really shouldn't just try to avoid them.

It's interesting. It makes me want to be a creditor. Okay, don't avoid the creditors, try to work with them. And then it really depends big variable and how much leverage they have over you and how important it is to overcome that. One of the things we didn't talk about, stalking horse bid, one of the cool, sexy M and A slang terms. Can you explain what that is?

A stocking horse bidder In a chapter 11 is actually the court ordained lower price for an M and A transaction. So if you go into a Chapter 11 case knowing that you're going to try to sell the company, you might actually try to line up your stalking horse bidder ahead of time. And basically then the stalking horse bidder provides the floor price in an auction and the contract that they've negotiated is going to be the base contract that all other bidders have to work off of. And in exchange for that, the stocking horse bidder gets bid protections. So nobody else in the deal is able to be awarded any break fees except for the stocking horse bidder who's approved by the court because they're protected performing this function of again setting the floor price. But they can get a break fee of 3% of the value of the transaction plus expense reimbursement, which could be pretty significant if they're the ones that are doing all of the diligence upfront.

Wait, they get a break fee? That means.

So yes, so they get a break fee because their bid is potentially being shopped to other people. They get a break fee that comes out of the proceeds of the topping bid. So if you have a stalking horse bid of 100 million and there's a 3 million break fee, then the next best bidder has to come in at.

I can make a business just doing stocking horse bids, but you have to.

Show of course that you're able to buy the business if nobody shows up.

But it could still be pretty value based bid. And then if I get it for the price, it's a good deal. But if I get topped, still get paid on it. Could people do that?

Yes. A lot of people want to be the stocking horse bidder because you get those bid protections. But it's just another tool that the debtor has. Because not every auction has to have a stocking horse. Right. If you think it's a valuable business and a lot of people are showing up, you might say it's not worth paying the bid protections because that precludes other bidders from coming in unless they pay the break fee. I'm just going to run a naked auction and let everybody go up. But if it's a business where you're trying to hold it together a little bit more, or you think you need that floor price to really get people up in value, then it's a very powerful tool.

That's fascinating.

There are a lot of dynamics in how you can set the auction procedures. The stocking horse has to be approved by the court because you're using estate proceeds. So they have to approve the fact that you are granting them potential bid protections.

There's a lot of expenses that go into this because we're trying to protect the business so it can continue to operate. And there's obviously a bunch of opex that the company has to manage. Does the court manage all that stuff? They have to approve everything. How does that work?

They have to approve everything that is outside the ordinary course and they have to approve significant expenditures. So often one of the first things you do either on the first or second day is you go to the court and you say, I want to pay this amount in wages, I want to pay my usual vendors and payables. And the court basically blesses all of that. But the protection you get is you don't have to pay anything that happened pre petition, so all of that is halted. If you owed a major vendor $100 million, but then post petition you're continuing to pay them in the ordinary course, that $100 million would be an unsecured claim and you don't have to necessarily pay them at the outset of the case.

Okay, so stuff that before you don't have to worry about protects you from that. But then if there's some specific big expense coming up, things out of the ordinary, you'd have to get that approved. Otherwise you can still run your business. What if you're in a really bad shape where you're even struggling to do payroll and stuff like that?

In that case, typically it ends up in a liquidation.

It moves pretty quick to liquidation.

Yeah. If you're administratively insolvent and you can't pay your ordinary payroll and you can't pay your advisors, you're probably in a liquidation situation.

Sounds a lot quicker in liquidation. What are some do's and don'ts we haven't covered?

The key don't is don't panic. People think about bankruptcy as like this terrifying thing that departs so much from the usual ways of M and A But it tends to be a very orderly process that has a lot of helpful tools. You have to get used to the court process, you have to get used to everything being done publicly and your creditors objecting by. You have a lot more time. And once you actually get into it, people can sort through things very well. And so don't panic if you're going into bankruptcy. Don't panic when you're in bankruptcy. Don't panic if the sales process isn't going well. Because most of the time your bankers and your lawyers can come up with something to help fix it.

Stay calm, Stay calm. How about on the buy side? I always get excited when I hear about bankruptcy deals. I've worked on a handful that were more real estate oriented and there were things that you end up buying like 50 cents on a dollar. Those are good wins for clients way back in the day. But as somebody that's interested in finding those opportunities, what's the best approach to do that? Because there's obviously bankers involved, but even attorneys directly who found helpful. And there's obviously public announcements too.

There are a lot of ways to find out if a company is in distress or selling its assets in bankruptcy. The company is much more likely to be listening to your inbounds. If you've got good bankers who can back channel and provide reasonable offers, you're much more likely to find a good audience for something like that.

So networking with bankers would be.

Networking with bankers.

Yeah, that'd be one.

That's probably true of most standard M and A too.

Know your bankers, know your bankers would help to know the attorneys directly.

The attorneys will be public, but they'll probably route things related to M and A through the bankers.

Okay.

Ultimately. But also know there's value to potentially being a stalking horse. So if you want to raise your hand and run for something like that, then you would be pushing for a break fee and to front run some of that process.

Do they ever sell these businesses without a banker?

It's unusual.

Unusual. Okay, so usually there's a banker involved.

Usually there's a banker.

That's your best bet. Network with the banker. What about following public listings? I know there's some companies that offer as a third party service you could.

I mean, I think it's mostly like debt hedge funds, distressed funds that follow things like that. If you're a strategic, I don't know if that's your best way in the market. You're probably going to know your competitors are close to bankruptcy or in a distress situation and ready to swoop in.

What about buying the debt and then being part of the fund?

You could also do that. You could buy the debt. You could buy the secured debt potentially if it's trading cents on the dollar and then you could credit bid it or you could put yourself in the position of being that fulcrum creditor. They have to listen to you in the case. So that's a way that's a toehold into taking over a distressed company.

Next podcast, how to buy debt. These are good approaches. And then any tips in terms of being involved in the auction process because that did not sound fun. I'm hoping to find these good deals where I'm thinking of a few companies I'm tracking now actually that may be getting in trouble. And I like to position ourselves as hey. As an alternative to winding the business down. That'd be more likely than bankruptcy. I'm just curious, is there other tips on the buy side of how do you get ahead on these deals?

On the buy side, it's always easier to get in before the bankruptcy filing because once the bankruptcy filing hits, it's public. You're dealing with all these other bottom feeders and everybody's trying to hold the business together. But if you can get in before the bankruptcy filing, either be the stalking horse or if it's not a company that would necessarily go into bankruptcy because bankruptcy is expensive. That's always helpful too. There's value in being the white knight in those sorts of situations. If you think that there's nobody else around.

The white knight.

The white knight. Another great emanator.

White knight.

The white knight is just. It is what it sounds like. It's the person that shows up to save the company.

Yeah. You got the black knight, which is a hostile person that shows up to take over the company. And the white knight is there to save the company. You're right. Is if you get ahead of it or you know the company's in trouble before they file bankruptcy and see what you can work with the principals, maybe come in and try to put them in a better spot with your own terms. Get some equity at it.

If you have financing. It's what the distressed company needs the most. Right?

You said bankruptcy is expensive. How do you budget for going bankrupt?

So it's hard. It depends on the complexity of the bankruptcy. If you already have a deal going in with some of your creditors, it's going to be a couple of months and then you'll have a much better sense of budget. And sometimes it's a free fall bankruptcy that lasts Much longer than you think it will. You are just burning expenses in bankruptcy. The lawyers and the bankers, they're all lawyers, certainly are charging on an hourly basis. All of that is public too. So if the fees are outsized, sometimes we do get criticized from judges who are approving all of those fees. But the fees for your financial advisor and your structuring advisor and your lawyer, that all gets approved upfront as well.

And the bankers, if they put a retainer in there and success fees all comes from this.

Yeah. And it would come from the top. So most of those fees are treated as priority claims.

But it is expensive.

It's expensive.

I think that's my moral of the story, is try to avoid bankruptcy altogether and really do what you can with those options that we talked about. Negotiate with creditors, raise some additional capital. What's the craziest thing you've seen in.

M and A in distressed M and A, other than ftx, which is its own story? I had a bankruptcy deal where we were hoping to run an auction. We didn't quite manage. We had one buyer who was sitting there and the other buyer didn't show up. So we went to court to get that approved and all of a sudden somebody comes riding in with more money and finally financing commitments into the courtroom and said, I have a better offer. We had to adjourn the court proceeding. We were trying to approve a different deal and negotiate a better deal in the courtroom. That happens.

It was like a super last minute.

Somebody came in all the way up. Until it's approved by the court, somebody can come in with more money.

Wow. It doesn't sound like there's a bunch of crazy deals that happen in auction. Sounds like it's really designed to get the most value of what's there.

Yeah. It tries to funnel things into an orderly process, but the more you do bankruptcy, the more you realize it's not necessarily that easy unless it's super complicated.

And nobody wants to deal with it, I guess.

Yeah. This is great.

Amy. Thanks so much for taking the time. You taught me a lot about bankruptcy today, helped me become a better M and A scientist.

Thank you for inviting me. This was a great job, fellow M.

And A scientists, if you made it this far. Thank you. I appreciate you listening. This was a podcast listener suggested topic, by the way, so feel free to reach out to me. I love getting different ideas on improving the podcast as well as I take the criticism when I get good at this. Till next time, here's to the deal.

Foreign.

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