LA REFINANCIACIÓN FINANCIERA

Trabajo de Nicole Soria 5/11/2014

Asignatura: Finanzas Corporativas II

Profesor: José Miguel Salazar Olivas

Index

1.

Introduction

2.

What is a financial restructuration?

3.

When is it necessary to do a financial restructuration?

4.

Goals of the financial restructuration

5.

Fases of the financial restructuration

6.

Refinancing costs

7.

Conclusions

Bibliography

1. Introduction

The financial and economic crisis that began in 2007 was generated, among other things, by an excessive debt taken on by households and firms. In a market environment with very modest direct payoffs, all agents sought to force the total return with higher borrowing without considering the consequences in terms of risks. In recent years the continuity of many companies has been guaranteed by the negotiation of restructuring liabilities. Indeed, companies in different industries have survived because of their ability to restructure and refinance debt. With a restructuring of debt you can obtain a private agreement on future terms and conditions of debt in order to make feasible the company when there is already a current or imminent situation of financial failure. In other words, this is about divide the company's cash flow among the various capital providers and other creditors in order to avoid a bankruptcy or a too expensive liquidation for the various economic and social actors involved.

2. What is a financial restructuration?

The financial restructuring is a process that involves the reorganization of the liabilities of a company, it relate any change in the financial structure, made in order to regain solvency and increase the value of the firm, so as to reposition it in a good economic position (in terms of profitability) and financial (in terms of liquidity). This process involves the restructuring of the assets and liabilities of the company, including the debt-­‐to-­‐equity structure. It promotes efficiency, supports growth, maximizes value for shareholders, creditors and other stakeholders; these goals, however, make it seem that the restructuring is done pro-­‐actively on the order of the board of directors: actually, the reasons are mostly defensive, for example, to deal with the threat of creditors who want to assert their rights, or to avoid bankruptcy, or when there are serious problems with the business. All this stems from a mismatch between the cash flows generated from operations and financial commitments for the repayment of debt; then the question is not only to repay the debt, but it is to solve a financial problem that exists from the base. The restructuring provides as first an analysis of the debt situation of the company, and then the formulation of strategies for a re-­‐discussion of the debt by the parties; these strategies will be implemented during a negotiation with creditors in order to create repayment plans acceptable to both the parties. Facing the possibility that the company may default on a loan, lenders can often change the terms of repayment, for instance by lowering interest rates or extending the repayment plan. In addition, the debt can often be converted, in part, into equity through two modes: the emission of new shares in order to pay debt or by giving a share to the creditors (in this case they have an ownership). Refinancing can also indicate the replacement of an existing debt with another debt with different conditions. These conditions can vary greatly from country to country, province, or state, based on several economic factors, such as the inherent risk, the risk of ejection, the political stability of a nation, the monetary stability, banking regulations, the merit of the borrower's credit, and the credit rating of a country. As mentioned above, the financial restructuring of a company is a complex process that requires specific experience. Even if the company has already faced a crisis, it is not advisable to be fully involved into the process, because of the risk to neglect operational management inadvertently. All operational processes involve a high level of commitment, but the financial restructuring is complex and requires a lot of time and resources. For this reason it is important to hire expert consultants, in order to reduce the risks and maximize the success of the operation. The trust in these people is crucial, and for this reason the top management must choose a good advisor, who meets the following qualifications: I. Documented experience. What is unknown to the client should not be for the consultant, who is familiar with these operations. II. Prestige. Creditors, especially financial ones, trust the opinion of a consultant to assess the profitability of the company. Therefore, it is important to have a consultant whose work is recognized and valued by financial institutions. III. Multi-­‐disciplinary knowledge and global. A purely legal approach is insufficient and limited. The restructuring of a company requires an economics, entrepreneurial, tax and legal

knowledge. Who wants to start an operation of this type should hire a consultant to provide a multidisciplinary knowledge and experience that can hardly be provided by a lawyer. IV. Management skills. The restructuring does not always work successfully in all the companies; in some cases, the only alternative is bankruptcy. Therefore, the consultant must have experience in this field and also he must have the ability to cope with a temporary management of the company. Naturally, the presence of an alternative interlocutor in addition to the existing ones will facilitate a better negotiation for all parties involved.

3. When is it necessary to do a financial restructuration?

A financial restructuring process is carried out when it occurs within the company a reasonable doubt as to its ability to meet its obligations to creditors (usually these are financial institutions, commercial lenders, public institutions, etc.). The causes of the need for restructuring usually reside in problems relating to the company (problems of operational management, financial, etc.), which usually flow into poor business results. Any threats or sectoral changes in the cycle of economic activity too may be grounds for a financial restructuring. The process of financial restructuring should not be made when the company is already suffering from a lack of liquidity or as an alternative to bankruptcy, but must be the result of a previous analysis involving detailed monitoring of both macro-­‐economic aspects (general indicators of the economy, confrontation with competitors, regulatory frameworks, etc.) and micro (profitability ratios of the company, financial ratios, etc.).

4. Goals of the financial restructuration

The existence of a conjunctural problem should not damage the good name and reputation that the company has built over the years. However, it has to be cause for a reflection and an internal discussion on the validity of the current business model. This implies the need to make difficult decisions, to question on the business model, to evaluate the ability to sell goods, and to provide additional resources to reaffirm the commitment of the shareholders in the project. Therefore, the first goal is to become solvent again and demonstrate to financial and commercial creditors the existence of a viable project in the short and medium term, with the full support of the shareholders, in order to achieve the most important goal: to restore the value of the company. Other (minor) goals of the restructuring are: 1. To take advantage of a lower interest rate 2. To consolidate more debts (if any) into one loan 3. To reduce the monthly repayment amount (for a longer term, for example) 4. To reduce or alter risk (for example, switching from a variable-­‐rate to a fixed-­‐rate loan) 5. To free up cash

In the event that the preliminary analysis of the business situation proves that the only solution is bankruptcy, the main objective of the consultant will be to assist the shareholders in accordance with the criteria established by bankruptcy law, to ensure the preservation of the heritage.

5. Fases of the financial restructuration

In the process of financial restructuring each operation has its own peculiarities, which may make the process to require specific approaches and variations for each case. Anyway, the main steps of any restructuring operation are the following:

Step 1: The mandate, a basic agreement between the client and the consultant Assuming that any restructuring operation requires the intermediation of consultants, it is essential to adjust the relationship between client and consultant under a contract of mandate to regulate the following considerations: definition of the services provided by the consultant, obligations of the parties, methodology (exclusivity clause, privacy ...), staff, salary and a provisional timetable. In short, the agreement commits the consultant, which defines the services to be provided and his obligations, and the customer too assumes certain obligations to continue with the restructuring.

Step 2: Preliminary tasks: analysis of the current situation As a first step, it is essential to conduct a thorough study of the current situation of the company and its recent developments, from the point of view of the balance sheet and income statement, and in terms of cash flow. The analysis of the company should be supplemented by meetings with the management team, and will be aimed at determining the causes that have led the company to begin the process of restructuring. This phase therefore includes a strategic thinking, in which the consultant will evaluate the different opinions of the board of directors about the current situation of the company. This is vital to understand the sources of generation and destruction of cash flows of the company, as well as to evaluating the creditworthiness of our customers.

Step 3: Preparation of Business Plan Update or, if not available, prepare a detailed business plan that includes the current situation of the company, as well as future projections expected within 2-­‐3 years. The basis for projections of future financial needs has to be the initial business plan, and it should include aspects such as the introduction of operational improvements, any redefinition of the business, the development of alternative lines of business, etc. All of these actions, well supported and sustained, will give comfort to creditors. Maintaining the status quo in these situations undermines the credibility of management and therefore the company's team. This business plan should be aggressive when it comes to cutting costs.

From the business plan you will prepare a cash budget that provides visibility to operative cash flows in the short/medium term. The cash flow will assess the company's ability to meet its obligations to existing trade creditors, banks, and other creditors. In addition, the development of different scenarios, with a focus on the critical variables of the model, will allow that the management team and the creditors can manage and evaluate the uncertainties that threaten the future of the company.

Step 4: Develop a financial strategy based on the business plan of restructuring The generation of a tool that allows to know the cash surpluses or requirements is essential when designing a strategy to repay the debts. Based on the results of the analysis of the cash flow there will be several alternatives for negotiating with the creditors, such as extending the life of the debt, change the terms of repayment (interest) or ask for additional funding. The current level of liquidity, as well as the money that the company is able to generate in the coming months, are the key to determining whether the continuity of the business is feasible or if failure is inevitable. One of the most important elements in this type of process is the management of the time, both in the case of continuity and in the case of failure. The failure does not necessarily lead to the liquidation of the company, but it may enable the company to benefit from certain features that may be the key to continue the busibess. For this reason it is essential to speed up the decision-­‐making process, because if the damage becomes irreversible then the liquidation becomes inevitable.

Step 5: Identification of actions and additional guarantees Before to begin contacts with the creditors, it's important to conduct a brainstorming exercise with the owners of the company about what they can offer to the creditors. The most common actions today are the increases in capital by actual shareholders, the pledging of assets or an extension of the guarantees, a cost reduction or a sale of assets, etc. You may also want to consider the inclusion of a new shareholder, even if the value of shares held by the existing shareholders drops due to the entry of another party.

Step 6: Develop a Memorandum The structure of debt in companies is governed by the terms and relationships that determine the payment obligations and the levels of financial solvency charged to borrowers. To verify that the conditions are met, there is a flow of information between borrowers and financial institutions so these can monitor the first (the borrowers). In this way, financial institutions will not be surprised by the financial difficulties of the companies. The information that financial companies will require in the first place during a restructuring is not the current

budget, but a detailed document explaining the weaknesses of the company and the proposed solutions. Therefore, it is essential to develop a memorandum containing all aspects of the preceding paragraphs: detailed information on the causes that led the company to the current situation, measures, actions, and strategy set by the company in order to ensure the success of the refinancing plan . This memorandum constitutes the basic document to begin negotiations, and its evaluation by creditors is crucial in order to certify the credibility of the company and its management team. Thus, both the memorandum and the financial projections should be characterized by a high degree of caution, given the trends in the specific sector of the company and the economy in general. The use of alternative scenarios that raise awareness of the critical variables of the company brings more value to the analysis.

Step 7: Presentation of the memorandum to the creditors and negotiation At this step the memorandum prepared is presented to the creditors and they are informed about the actions that will be needed to ensure the viability of the company and the fulfillment of obligations to themselves. As mentioned above, the strategy about the shares that shareholders are able to offer must be prepared before the first meeting with the creditors. This is because the first question to the company, especially by banks, will be delivering additional guarantees from the shareholders. At this point, the consultant has an extensive knowledge of the company and has been actively involved in the entire process of creating a negotiating strategy. This experience, combined with the importance that creditors, especially banks, give to being able to rely on a partner who is familiar with this type of process, will facilitate the negotiations. Negotiation is a complicated process, and it is more complicated in case of a restructuring. It requires technical expertise, flexibility and imagination. Having a powerful legal service is a key requirement at this stage, since the term sheets, which contain all of the terms and conditions that has been negotiated and are the basis on which all contracts will be drawn up following the restructuring, are very sophisticated . Therefore, it requires a high technical level and a high level of legal expertise in the event that the company which faces the restructuring process also incurs in a failure proceeding. From the legal point of view, the solutions in the context of corporate restructuring can be complex and varied, and require a multidisciplinary approach to take the most appropriate decisions for the case. For those reasons, it's necessary to coordinate the various legal areas which affect the business (such as company law, labor law and taxation law) in order to develop the project that best fits the situation of the company, and also it's essential to understand the practical difficulties of the company and its characteristics (such as the sector of activity). The legal advisor must also have the ability to communicate and to understand the financial advisor, in this way he can translate the needs identified by the financial advisor into legal documents. These documents should be an effective response to the problems of the company,

and there is no doubt that the success of the operation depends largely on the experience gained in this type of communication.

As we have seen, restructuring is a complex process, which requires time consuming, skills, knowledge, and has a high risk. The company which need for a financial restructuring process should take into account all the circumstances and must be extremely selective in choosing a good consultant to minimize the risks and maximize the result.

6. Refinancing costs

In case of a financial restructuring there will be some extra costs. For example, a debt can be repayed by doing another debt, but some loans with a fixed term have penalty clauses, which provide for the payment of some "closing fees" in case of an early repayment of the debt, in part or in full; for those reasons the company could have to pay these fees beyond to the normal transaction fees on the refinancing.

If a loan is paid off upon maturity it's a new financing, not a refinancing; if the refinanced loan has the same interest rate as previously, but a longer term, the costs would be very high. Typically, a refinanced loan will have a lower interest rate: this lower rate, combined with the new longer term, will ensure that the interest is diluted over time. The company should calculate the total cost of the new loan compared to the existing one; the new loan cost will include the normal closing costs, prepayment penalties, and the interest paid over the life of the new loan. If the costs of the new loan are higher than the previous one, it 's not convenient to do the refinancing.

All these extra costs must be calculated before embarking on a restructuring, as they can destroy any savings generated through refinancing.

7. Conclusions

Restructuring is a unique and complex process that should not be implemented too late, where the banks are in a position of advantage, and the solutions are not always perfect, but they can help the company to continue its business without necessarily resorting to failure. The Key Success Factors to be considered by a company in order to deal with a financial restructuring process are many, but we can summarize all into the following points: -­‐ Be proactive, try to solve problems related to insolvency before the situation becomes irreversible. -­‐ Identify the causes of the problem of liquidity. -­‐ Develop, before the bargaining, a financial and operating business plan to improve the company's liquidity; this plan must be coherent, credible, attractive and fair to all the other parties. -­‐ Develop a trading strategy, anticipating the difficulties that may arise during the negotiation and offer guarantees. -­‐ In case of conversion of debt into equity, it is necessary to negotiate in detail the value of the participation of new members, or find alternative sources of capital (as the venture capital). -­‐ The success of the restoration depends largely on the selection of qualified consultants: their role is crucial. -­‐ There must be a continual strategic review, even after that the restructuring took place.

Bibliography

Articles: “Operaciones de reestructuración y refinanciación financiera (II)”, in “Estrategia financiera”, n.288 noviembre 2011.

Books: Ciompi R., “Ristrutturazione Finanziaria di un'Impresa. Guida Strategica al Riassetto Aziendale dall'Analisi al Finanziamento.”, Bruno Editore.

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