Founder and Principal

 

 

April 2013 Vol. 2 No. 4

 

 

 

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Goodrich & Associates
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I have been working this week on a "Waterfall Chart" - a chart that shows how much money creditors will be paid, once funds are received and distributed.

What makes this project unusual is that my client is not a commercial enterprise. Rather, it is two interrelated nonprofits. The only assets of value are cash and "assets" for those that benefit from this non-profit, but they are a cash drain and have no economic value.

The cash is from donor contributions and more cash from donors is needed. The donors, however, have no idea of the wind down costs involved and expect the creditors to receive a modest payment. Most of the donors also sit on the Board, thereby exposing themselves to liability if the organization is not wound down properly. The donors are tired of writing checks and I need a check from each of them. The waterfall analysis, will help show them where the money goes, the risks of not completing the steps, and that yes, this will be the last check.


What is "Waterfall Chart?"

Simply put, a waterfall chart is a tool that shows the flow of funds to creditors when some creditors are paid before others. In a situation such as a bankruptcy, where there are not enough funds to pay everyone in full, the order of payment (i.e., the flow of funds down the waterfall) matters a great deal.

Typically, the flow of funds is as follows: expenses incurred while liquidating the assets used to pay the creditors are paid first; then wages; then unpaid taxes; then vendors; and unsecured lenders. If there are secured lenders, they have the right to grab everything first, until the loan is paid off.

The waterfall chart will usually show the assets being liquidated and the expected value from each. These assets are often listed in detail, so that the impact of fluctuations in their recovery value on creditors can be tracked. The expenses incurred while liquidating are often tracked and projected on a weekly basis, as these expenses can greatly affect the size of the distribution to creditors, particularly those on the bottom.


Why use a Waterfall Chart?

1. To set expectations. When businesses will be paid less than they are owed, falling short of estimates is never a good thing. By working through the distribution to key creditors and by tracking any factors that may effect that distribution, negative surprises are minimized.

2. To focus attention on what's important. A waterfall chart tracks the critical steps needed (with associated costs) to get to a distribution. It also tracks items higher up in the waterfall that may have uncertain values. These may include a tax liability, for example, because returns or an audit have not yet been completed. Variances in the items at the "top of the waterfall" obviously impact those below.

3. To understand the impact of price variations for assets that are being sold. As the liquidation process moves through time - from rough estimates of liquidation values, to feedback from brokers, to bids from buyers - the range of expected values narrows. As these changes in value happen, a waterfall chart spells out the impact on creditors and the liquidation process.

Things to consider:

• Consider the impact of time. The more time between now and a distribution to creditors the more time for expenses to add up and the unexpected to happen. Forecast liquidation expenses on a weekly basis and increase the size of the contingency allowance the farther out the distribution. Also, some liabilities grow over time due to contract particulars; in these cases, the timing of the payout matters.

• Keep close track of professional fees. Attorneys and many other professionals are known for billing on a less than current basis. In a bankruptcy setting, these fees are considered administrative claims, part of the expense of the bankruptcy itself, and must be paid or feasibly be paid, in full, for any Plan of Reorganization or of Liquidation, to be approved by the Court.
  
  For one client, for example, I became the sole Director and CEO of a Delaware company well through the bankruptcy process. The major assets had been sold and my job was to drive the case to a liquidating plan that could then pay creditors. The first thing I did was look at the budget and waterfall.
  
  I asked the CFO and Controller questions about professional fees and got murky answers. Unfortunately, the controller had been tracking legal bills that had been approved by the Court but had no idea about fees incurred and not yet approved (or even submitted). Estimated unpaid legal and other professional fees exceeded cash in the bank and all the major assets had already been liquidated.
  
  In this case, approving a Plan of Liquidation then became dependent upon either liquidating hard to liquidate assets or getting those Professionals involved to reduce their fees. I had no choice but to halt all payments to Professionals until the remaining assets were liquidated.

• Keep an eye on items for which employees and governments can look to the Directors and Officers for payment. Most of those involved know to pay wages, vacation and payroll withholding taxes. But don't forget sales tax owed as well as ensuring that the 401(k) and other pension plans are properly wound down, with all necessary forms such as the 5500 sent to the Department of Labor (often this requires an audit of the plan). Sometimes these expenses don't get the highest priority in payment, particularly if a secured lender and/or the costs of the liquidation, consume all the funds.

A waterfall analysis is a powerful tool, and certainly not limited to bankruptcies and liquidations. In these cases, however, where time is of the essence and the flow of funds is sure to run dry before all creditors are paid in full, it is of particular value in creating and managing a rational plan.

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Many of us look at the world through the lenses of business, finance and economics. From time to time, however, it is beneficial to consider a different view. One such alternative is the lens of geopolitics.

George Friedman is the Founder and Chairman of Stratfor, an international security and affairs advisory firm. In his recent newsletter, he talks about world politics entering a new era with the United States in a stronger position than before.

You can read his views and perspective here.

Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent financial problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.

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