Rescuing and recapitalising a business: triangulating your offer

McWilliam’s Wines Group is currently in the process of being recapitalised via a Deed of Company Arrangement (‘DOCA’). Although the press reported members of the McWilliam family had proposed an alternative DOCA to regain control of the business, a private equity firm was ultimately the successful DOCA proponent.

Why was the private equity firm’s proposal more attractive to the Voluntary Administrators (‘VA’) than the opportunity to return the business to family hands? The key to answering this question is an understanding of the lens through which a VA assesses offers it receives.

How a VA assesses an offer

A VA is not a long term owner of the asset and does not have a ‘hold option’. Instead, a VA has duties to creditors and often needs to deal with the commercial realities of distressed trading and personal liability for debts it incurs whilst controlling the business. Due to these factors, a VA will assess the merits of offers it receives in an insolvent sale process in a different manner to that of a vendor in a solvent sale process, where value is the primary consideration and holding the asset may be a reasonable fall back. The VA’s assessment seeks to balance:

• Value, including an assessment of the liquidation value of the business, setting the benchmark against which offers are considered;

• Price certainty; and

• Execution risk e.g. timeline to completion (speed is key when there is cash flow pressure) and the conditionality of offers received.

Additionally, the VA will weigh up the risks and benefits associated with deal structures put forward by bidders. In essence, the VA will balance value offered against liquidation risk when considering typical asset sale or DOCA deal structures as follows:

• Asset sale – a VA can use its powers of sale to enter into a transaction of this nature without seeking creditor approval and this can therefore significantly increase certainty of the outcome; or

• DOCA – which involves a recapitalisation (“cleansing”) of the insolvent entity often coupled with a share-sale or share-transfer. The VA needs to put the proposed DOCA to creditors whose support (majority vote in value and number) is required. Overly aggressive or highly contingent DOCA proposals may not secure requisite creditor support and the uncertainty pending creditor approval represents a risk to the sale process. Generally, a DOCA is a more complex transaction and as such a DOCA proposal should be presented as clearly and definitively as possible, ideally supported by legal advice, as was the case on McWilliams Wines.

What should bidders consider when preparing their offer to an Administrator?

1. Bidders must triangulate value via:

• Their own estimate of the group’s liquidation value;

• The value of the assets or business units being acquired and any assets left out of the deal, for the VA to realise; and

• More typical views (e.g. earnings multiple or DCF) of the value of the business based on the turnaround forecast, and the associated ROI.

2. Bidders must mitigate perceived or actual completion risk:

• Onerous conditions precedent may extend the timeframe to completion and may be unacceptable to a VA who is facing significant near term cash flow pressure;

• Support of secured creditors (who are not bound by DOCA) should be sured up early on; and

• Interim liquidity support may need to be provided to the VA (on preferred terms).

3. Bidders will also need to consider the deal structure put forward to the Administrator:

• A transaction that delivers a meaningful upfront distribution to creditors presents more favourably than a protracted liquidation process where value remains untested;

• Additional value offered by putting forward a DOCA deal structure should be balanced with potential liquidation risk resulting from the creditors voting down the DOCA; and

• An opportunity to participate in longer term valuation upside (i.e. earn out structure) may also be attractive to creditors.

This blog is part three of the ‘Rescuing and recapitalising a business’ series. Previous blogs in the series can be found via the links below.

• Part one: An introduction

• Part two: Due diligence – validating the ‘upside’

In the next blog in the series we will discuss deal structure in detail and walk through key considerations when proposing a DOCA.