Business Triage

Typically, if you have a viable business with strong customer support and a strong management team, the other factors that may be important in determining whether the company can survive work themselves out. If any one or all of the three above listed factors are lacking, it will be difficult, if not impossible, for the company to survive, and certainly, at the very least, other factors become more critical to its long-term success.

Viability of the Business

Can the company sustain itself? Is the company economically viable? In other words, is the company, at the very least, breaking even on its operations, will it be able to break even once restructuring occurs, or is it going to lose money no matter what? I have seen a number of cases where despite a very strong management team and equally strong customer support, there is nothing that the company will be able to do to survive because of inappropriate pricing on contracts.

Customer Support

It should come as no surprise to anyone that if customers do not support a business it will not be successful long term. Even if the company is very viable in that it is making loads of money, if all of the customers resource their business away from that company, it will obviously fail. Similarly, I have seen situations where the company has some significant problems in a whole host of areas including significant secured and unsecured debt, little or no lender support, and weak management; but if the customers strongly support the business, that business may be able to survive.

Customers may support businesses for a number of different reasons. One reason, of course, is that they are getting a good product from that business, and they want the company to survive to continue to provide that product. Another reason that somewhat dovetails with the first is that the customer may be unable to get the product from another source or may not be able to get it in a timely manner from anywhere else.

Management

An average business not in financial trouble needs a strong management team. However, the need for a strong management team is even more important if the company is financially challenged. This includes not only good upper-level management, but also competent operational and financial management. Certainly, if a company has a weak management team, it can lose the support of its customers, its creditors and its lenders.

Other Factors to Consider

If any one of the above three factors are missing, there are other factors that become more critical. These other factors include: 1) debt-to-equity or total debt to EBITDA ratios; 2) the support of trade and unsecured creditors; 3) the support of the company's lenders; 4) the cost of production (is it consistent with the industry standard?); 5) the condition of machinery and equipment (is there a need for significant capital expenditure?); 6) the support of the workforce and/or union; 7) unfunded pension and other benefit liabilities; 8) competitiveness in the industry with pricing, quality, delivery and support; and 9) pressures in the industry for optimizing the supply base in which the company operates.

Debt to Equity or Total EBITDA Ratios

It is probably the goal in most industries to have a 2 to 1 debt-to-equity ratio. Obviously, the better the debt-to-equity ratio, the more support the company is going to get from its lenders, its unsecured creditors, its workforce and its customers.

Further, based on the latest trends toward a more conservative banking policy, lenders have started to move away from the historical debt-to-equity ratios to evaluate debt load, and are more focused on cash flow targets such as total debt to EBITDA as a measure of debt capacity. With this model, the normal ratio would be in the 3.5 to 1 range. Obviously, like the debt-to-equity ratio, the closer a troubled company is to the target range, the less restructuring will be required and the more support the company will receive from its lender, its unsecured creditors, its workforce and its customers.

Unsecured Creditor Support

It is also important to understand the level of support, if any, from the unsecured creditors and trade creditors. To the extent a company needs its trade creditors to continue to supply going forward, it is obviously very critical to get their support. Depending on the industry, support of trade creditors may be different. In certain industries with a strong trade group, it may be more difficult to get concession and support without dealing with or paying those creditors in full on antecedent debt. Further, the company typically needs the support of these parties going forward on trade terms. As they say, “cash is king,” and to the extent the company has to pay for everything on terms cash in advance or cash on delivery, its ability to operate long term is jeopardized.

Unsecured creditors and trade creditors can dictate the direction a troubled company takes. If a troubled company is not getting the support of its unsecured creditors, for example, and these creditors are demanding payment on antecedent debt, thereby reducing the ability of the company to restructure, the company may have no choice but to seek bankruptcy relief. The filing would be for the benefit of obtaining the automatic stay pursuant to ' 362 of the Bankruptcy Code. However, bankruptcy relief may not solve the problem of a trade creditor refusing to ship to the debtor.

Lender Support

Another important factor is the support, if any, the company has from its lenders. Without the support of the lender who has an all asset lien, the company's ability to do business in the future will be jeopardized. Like unsecured creditors, the lender can dictate what path the company may reasonably take. Again, like dealing with unsecured creditors, the company may have no choice but to seek bankruptcy relief.

Cost of Operations Compared with Industry Standards

If it is costing the company a lot more money to make a widget than it costs someone down the street to make the same widget, the long-term success of the company obviously is in question.

Condition of Machinery and Equipment

If the company is already suffering financially, and is having difficulty merely funding its ongoing operations, to the extent significant capital expenditures are required, the company could be in severe jeopardy. Accordingly, it is important in evaluating whether a company could survive long term to look at what significant capital expenditures are required over a course of time and possibly looking out several years. If the company has machinery and equipment that is in disrepair, for example, even if it starts operating at a profit, unless there is some mechanism to make the required capital expenditures long term, the company is going to end up back in the distressed situation that it currently sits.

Workers' Support

Likewise, to the extent that a company has difficulties with its rank and file, the company is most likely going to have problems. This type of issue can even create problems with customers. If the workforce potentially jeopardizes ongoing production, the company will find that its customers are not as supportive of its long-term efforts.

Unfunded Benefit and Pension Liabilities

As to unfunded benefit and pension liabilities, this can be the death knell for a company if such liabilities are significant. These are typically, without huge concessions by the beneficiaries, obligations that cannot be avoided and can put companies out of business.

Competitiveness

A lot of industries require that companies be competitive in pricing, quality, delivery and support. If a company is lacking in any of these competitive areas, it will lose its customers' support.

Shrinking Supply Base

Another factor that may jeopardize a company's long term viability are pressures in the marketplace to optimize or shrink supply bases.

Conclusion

Using the triage method is a simple way to take stock of a company before things go too far and it ends up in bankruptcy court. Evaluate each factor carefully and if you are still not sure about a company's viability, move on to the other factors before making a decision. The key is to see the business through an objective eye and the overall big picture of the company's place in the economy.

James A. Plemmons is a member in Dickinson Wright's Detroit office and is practice department manager: Automotive, Bankruptcy & Insolvency and Product Liability Litigation, for the firm. He can be reached at [email protected].