Why your assets are probably worth less than you think.
July 2017 Vol. 6 No. 7
Hello,

Sometimes, and when all efforts at turning around the business have failed and there are no buyers or sources of new funding, the only option remaining is liquidation. At best, it's a difficult situation, and management often fails to grasp how low the recovery will be.
Today's newsletter looks at why assets in liquidation are worth far less than most business owners think.
Regards,
Charlie Goodrich
Founder and Principal
Goodrich & Associates
In this issue...
Why Your Company Is Worth Less Dead Than Alive (Much Less)

I help my clients with urgent liquidity problems. Sometimes, and when all efforts at turning around the business have failed and there are no buyers or sources of new funding, the only option remaining is liquidation. At best, it's a difficult situation, and management often fails to grasp how low the recovery will be.

There are two reasons for the surprise. The first is that burial costs are often higher than assumed. The second - and the subject of today's article - is that assets are worth far less than most business owners think. 

Let's talk about why...

A business can be thought of as a collection of assets and people that when combined create economic value in excess of their cost. The value of the assets is a function of their ability to generate a profit. The problem is that by themselves (i.e., once the business ceases to be a going concern), these assets individually are worth far less. They are old and tired and simply need to be monetized.

Recently, for example, I was retained as a liquidation advisor for a consumer products company. The company bought cheap goods from Asia and sold it to big boxes, chains, mass merchants and so forth, across five different categories. The company hadn't been profitable for years and sales were expected to decline 20%, thanks to the loss of its largest customer and the bankruptcy of several others. A two-year sale process failed to find any buyers.

Despite all that, the CEO was confident he could liquidate the company for 50 cents on revenue! Yes, revenue. And, secured debt was 2.4x projected revenue. Not EBITDA, revenue. Oh, and the CEO thought he was due a $1MM bonus, to be paid before he proceeded with the liquidation.

My analysis showed that under favorable conditions, the recovery would be around $4MM. Management and I flew to Chicago for what turned out to be a long, cantankerous meeting with the lenders. (The CEO had added another $7MM to the recovery the night before, because he thought he could sell one of the product categories.) In the end, the lenders agreed that $4MM was about right, the CEO was removed, and the liquidation began in earnest.

Why though, are liquidation values typically much less than what even experienced business people expect? In most cases, it's a function of faulty assumptions, including:
  • Isn't cash, cash? Well yes, but that doesn't mean you can access it. And here I'm not talking about secured lenders taking it or the accounts not being reconciled properly. Rather, most surprises come from unsecured creditors. For example, bank accounts can be attached, either by governments to collect taxes or other, non-government creditors. In some states, no notice is required.

    Back during the dot com bust, a client's bank account had been attached by multiple creditors, something I discovered by opening a letter that was notice of a hearing, after the account had been attached. Currently, I am liquidating a broker/dealer that has a large chunk of cash with what is called a "prime broker," a large international bank that facilitates the execution of trades and has custody of the securities. My client can't move money out of the prime brokerage accounts until all trades have cleared, positions wound down and debts with the prime brokerage settled.
  • Can't accounts receivables be collected at face value? Not usually. For example, the consumer products company I mentioned earlier never cleared out customer deductions, which are substantial in their business. So their A/R was not reflective of true value. In other cases, and because your customers know you are going out of business, they may offset what they owe you with what you owe them. Or, under the legal theory of recoupment, they may deduct additional expenses from what they owe you as "claimed losses" for your inability to complete the contract. The point is, once you begin liquidation, your customers are in a position of strength and will likely negotiate accordingly.
  • Our finished goods are worth something, right? Something, yes. And sure, maybe you get lucky, particularly if you make custom commercial or industrial products, and a vendor will pay you to keep operating. But that is not the norm. In many cases, excess inventory is there because customers didn't buy it. Excess and unsuccessful products are sold in bulk to liquidators such as HILCO and Gordon Brothers (if not dropped straight into the dumpster). These liquidators, in turn, sell to discount retailers, Africa, and everyone in-between. The bulk buyer wants to make a profit, so inventory goes for far less than you would think. Ongoing warehouse and other costs don't give you the luxury of selling little by little.

    Do the finished goods use the licensed trademark, patents, etc., from someone else? Then you probably need the licensor's permission to sell the goods outside of an agreed upon channel. Worse, you may be in default with the licensor and have no rights at all. Your business doesn't sell to retailers? Your outlets for surplus finished goods won't economically be that much different.     
  • What about raw materials? Those that are commodities can often be sold for close to cost. Specially ordered parts or packaging with a customer's name on it, on the other hand, can not. There are ways to be creative, but that just gets rid of the inventory and rarely brings significant dollars.
  • How about the fixed assets that we just paid a lot of money for? Even with an appraisal in hand for a recent loan, you need to keep in mind that the appraiser knew the lender wanted to do the loan and gave the lender an appraisal to justify it. You're no longer a viable business; reality has shifted. Remember as well that there may be significant costs to install/remove fixed assets that are not recoverable. Plus, shipping, profit margin for someone to resell, etc. Here too, the dollar recovery is usually low.
  • Okay, but how about the intangibles? We've got patents, trade secrets, brand names, customer lists and more. Yes, they are worth something - but to whom and what are they going to do with them? Your business owned and used those intangibles and it failed. So while it's true that people will buy brand names in the retail world, these are liquidators that take an old tired brand name - for which they paid little - and use it to put logos on fresh, cheap merchandise that will help them liquidate the next retailer. Odds are, your business is liquidating because there were no buyers - at any price - for it.
Shutting down a business is a painful process; there's a reason why it is the option of last resort. Don't get carried away with what you think you will get out of a liquidation. Sometimes, you get lucky, but most of the time you don't.

Please share with your colleagues
Heard on the Street

With all of the political talk about the need for "better" trade deals there has also been mention about the perennial balance of payments deficits. That is, the United States imports more in goods and services than it exports.

Ana Maria Santacreu, economist with the Federal Reserve Bank of St. Louis, notes that this deficit is entirely a result of a deficit in goods. The United States has a surplus in services, mostly from travel and royalty payments for intellectual property. Read the short article here.

About Us

Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent liquidity 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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