Valuation for Mergers, Buyouts, and Restructuring, Second Edition

Chapter 14

Recapitalization of Troubled Companies

14.1 DEALING WITH FINANCIAL DISTRESS

Changes in economic conditions, overoptimistic projections, excessive debt, and managerial errors can precipitate default.¹ How to deal with a company in financial distress depends on if it is worth more as a going-concern than in liquidation. Salvaging the going concern requires a recapitalization of the company and the implementation of a turnaround plan directed to conserve cash, reduce expenses, stabilize cash flow, and assure economic viability. Liquidation involves an orderly selling of assets to maximize proceeds.

The purpose of a recapitalization is to reduce the burden of debt on the cash flow of the company to make it consistent with its debt capacity and to maximize the cash recovery of the different claimants. The tools of analysis for recapitalizing and valuing a distressed company are those developed in Chapter 7 on debt capacity and Chapter 13 on leveraged buyouts (LBOs). Independently of the ownership form of the original company, recapitalizing a distressed company is similar to structuring an LBO in the sense that both use all the debt capacity that can be realistically managed and that the cash flows available to many of the claimants are in the distant future. However, negotiation under distress is more complicated in that creditors attempt to preserve their claims and can force unrealistic amortization schedules. A credible, realistic analysis of debt capacity and a fair ...