How to Deal with Business DistressOverviewIf you have been in business for one or more recent economic cycles, you have seen growth and profitability in an up market and the crushing effects of a sudden downturn.

Sometimes, even in up markets, unexpected internal problems reveal themselves in bad accounting, lost leadership, and operational misses and external ones, like bolts from the blue, as in loss of a major customer, a lawsuit, or a pandemic.

As business owners ourselves, and as advisors and investment bankers, we too have experienced the downturns, and have successfully applied our expertise in turnarounds and bankruptcy restructurings.

We have helped our own companies and a variety of others fix internal systems, restructure staffing, negotiate bank workouts, reset customer and supplier relationships, negotiate IRS settlements, resolve environmental issues, and preserve, to the extent possible, shareholder value.

In this white paper, we want to share some of our learning. We have organized our recommendations around three overlapping, rapid-response activities for dealing with extreme business distress:

• Evaluation. SWOT analysis of the business to indentify and prioritize the causes of internal and external distress;

• Planning. Strategic planning, with an "optimal" plan and potential backup plans for quick pivots, including to bankruptcy, if necessary; and

• Execution. Launching the turnaround, negotiating a cooperative debt restructuring, and preparing for a bankruptcy filing if the cooperative restructuring .

Restructuring & Bankruptcy

CONTENTS

1. Overview

2. Evaluation

3. Planning

4. Execution

5. Conclusion

6. About Galena Capital

INVESTMENT BANKERS

Member FINRA

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Evaluation

Any restructuring plan will require the same level of credible due diligence and professional presentation expected for the purchase or sale of the business. In extreme distress, the audience expands to include the bank, other lenders, major trade creditors, key suppliers, landlords, equipment lessors, employees, and shareholders. Presentation, coordination, and collaboration for a restructuring plan will be critical to achieving a better outcome than shutting down the business and liquidating assets.

Getting your own experienced advisors on board early will help you objectively diagnose the problems, develop turnaround and restructuring strategies, and add credibility to the negotiations. Without a rapid response, enterprise value can erode rapidly as the business runs out of cash and your negotiating position deteriorates. Do not wait for restructuring advisors to be forced on you by the bank or by bankruptcy.

The following flowchart illustrates the usual decision paths and actions to restructure without bankruptcy and to prepare for bankruptcy if it cannot be avoided:

The best outcomes come from planning the strategy, working the plan aggressively, and keeping all options open. If efforts to fix the company are successful, and the holders of the company’s capital are cooperative, the turnaround may occur without litigation or need for bankruptcy. If not, company management and the board should be prepared to quickly pivot to operate, reorganize, or sell assets in bankruptcy.

With experienced restructuring advisors, undertake an unbiased evaluation of your business.

Pre-Bankruptcy Turnaround & Workout Chapter 11

NO

YES

Operational Turnaround

Capital Restructuring

Evaluation &

Planning

Systems

Negotiations

BalanceSheet

Income Statement

Strategy

Agreement

Involuntary

Voluntary

Pre-packagedPre-arranged

HearingsDisclosure Statement

& Plan

Confirmation

Asset Purchase

Agreement

Section 363 Sale

In Court Reorganization

Confirmation

Not

ices

Cour

tA

ppro

val

Not

ices

Cour

tA

ppro

val

Cred

itors

Vote

Auc

tion

Hel

d

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1. Cash flow statement and balance sheet issues 1.1. Cash flows 1.1.1. Current cash flows 1.1.2. Velocity of working capital 1.1.3. Projected cash flows for at least next 13 weeks 1.1.4. Cash flow management (collections, creditor relationships, essential suppliers for ongoing operations, etc.) 1.1.5. Sources of actual and potential liquidity 1.2. Assets 1.2.1. Long-term assets at fair market and liquidation values 1.2.2. Marketable intangible assets (patents, copyrights, trademarks) 1.2.3. Claims not shown on the balance sheet (net operating losses, tax credits, pending litigation claims) 1.3. Actual and contingent liabilities 1.3.1. Payables; supplier relationships, and current aging of payables 1.3.2. Bank and other secured debt 1.3.2.1. Security interests 1.3.2.2. Perfection 1.3.2.3. Pledges 1.3.2.4. Personal guarantees 1.3.3. Subordinated debt; terms 1.3.4. Contingent liabilities (labor, tax, environmental) 1.4. Equity holders and board of directors 1.4.1. Fully diluted equity holdings (cap table) 1.4.2. Classes of stock and rights 1.4.3. Convertible notes, options, and warrants; terms and timing 1.4.4. Holders of shares and other securities 1.4.4.1. Relationships with management 1.4.4.2. Willingness to help with additional capital or dilute 1.4.5. Board representation 1.4.5.1. Relationships

1.4.5.2. Willingness to cooperate in plans (pre-bankruptcy and bankruptcy)

2. Income statement issues 2.1. Revenue quality and potential strategies to improve 2.1.1. Pricing 2.1.2. Brand enhancement; marketing 2.1.3. How does your level of customer churn compare to competitors? 2.1.4. How do your terms of credit with customers compare to competitors? 2.1.5. Is your revenue highly concentrated in a few customers? 2.2. Margins. Potential for: 2.2.1. Labor concessions 2.2.2. Supplier concessions (pricing and terms) 2.2.3. Adjustments to fixed costs (lease and contract rejection) 2.2.4. Reductions in variable costs 2.3. SG&A and potential cost reductions

3. Operational issues 3.1. Management team 3.1.1. Experience, relationships, credibility 3.1.2. Need for turnaround specialists or other enhancements to turnaround team 3.2. Systems, controls, and processes. 3.2.1. Accounting systems and support 3.2.1.1. Quality of current staffing 3.2.1.2. Management reporting 3.2.1.3. Bank and other third-party reporting 3.2.1.4. Accountants and auditors 3.2.2. AR and AP management 3.2.3. Inventory management 3.2.4. Transportation management 3.2.5. Human resources 3.2.6. Government relations 3.2.7. Legal support (in house or outside counsel)

Evaluation: Due Diligence OutlineDue diligence may be organized by analysis of current and historical financial presentations, relationships with various stakeholders, systems, and other operational issues. Here is a sample due diligence checklist to inform the evaluation, planning, and execution of a turnaround and restructuring strategy.

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After the initial evaluation, the following will be important in developing and aggressively executing the plan of attack.

Planning

Know the Rights of StakeholdersIt is important to have a clear understanding of stakeholders’ relative rights to the assets of the company. These rights are defined by contract and by law, so the assistance of legal and restructuring advisors will be important in formulating strategies for negotiating with each stakeholder.

Major stakeholders will have their own advisors. Your legal and restructuring advisors will help you level the playing field.

Know the Value of the Business and its AssetsWith financial models, comparable company analysis, and other data, your turnaround team will provide current and potential valuations of the business and its assets. Valuation will be necessary for every step, including a potential bankruptcy.

Understand BankruptcyYour legal advisors should help you understand bankruptcy and its consequences. The bankruptcy process can be protracted, expensive, and dilutive for everyone; attention and resources are diverted to court proceedings, costs, and professional fees; and, bankruptcy stigma can linger for years in a business ecosystem.

Nonetheless, if a bankruptcy is inevitable, you and your team can mitigate the impact with preemptive communication strategies, effective project management, and other efforts to avoid surprises and move through the process quickly.

The sidebar to the right provides a summary outline of key features of bankruptcy law and practice and key considerations for planning.

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1. Pre-bankruptcy considerations

1.1. Who must approve

1.2. Cash flow requirements and financing the bankruptcy

1.3. Analysis of preferences

1.4. Plan for the exit before entering

2. Paths into bankruptcy

2.1. Voluntary

2.1.1. Pre-packaged & pre-arranged filings

2.1.2. Free fall bankruptcy

2.2. Involuntary

2.2.1. Who can file

2.2.2. Trial on payment of undisputed debts

3. Immediate effects

3.1. Protection of the bankruptcy estate: Automatic stay

3.2. Managing the bankruptcy: The Debtor in Possession (“DIP”)

3.3. Financing the DIP: Use of cash collateral versus DIP financing

3.4. Reshaping the business: Assumption & rejection of contracts and leases

3.5. Court supervision and timing

4. Exiting bankruptcy

4.1. Section 363 sales

4.1.1. Sales of assets free and clear

of liens and claims

4.1.2. The 2-Step sale process

4.1.3. Use of 363 sales instead of plans

4.2. Chapter 11 reorganization

4.2.1. Voting requirements

4.2.2. Cram down

4.2.3. Absolute priority rule

4.3. Chapter 7 liquidation

Bankruptcy Overview

A bankruptcy plan will identify stakeholders by class

and in order of priority.

The classes are generally (1) secured claims

(in the simple case, this is the bank secured by

the short- or long-term assets of the company);

(2) administrative expense claims for debts

incurred during the bankruptcy case; (3) priority

claims for pe-bankruptcy employee wages and

benefits, certain taxes, and consumer deposits;

(4) unsecured claims (e.g., trade creditors); and

(5) equity interests (the shareholders or members).

The "absolute priority rule" provides that a

Chapter 11 plan cannot be confirmed unless the

plan provides for each senior class of claims to be

paid in full before any junior class receives anything

under the plan, unless each senior class agrees

otherwise by a majority vote of the creditors holding

at least two-thirds in dollar amount of the claims in

the senior class.

Stakeholder Claims & Priority

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Execution

Restructuring Outside Bankruptcy – Turnaround StrategiesCollaboration, rapid access to accurate information, and careful cash management are among the prerequisites for a successful turnaround. Restructuring the capital stack will require a credible plan, compelling presentations, effective negotations, and clear-eyed understanding by all parties of the purposes and consequences of a bankruptcy.

Communicate with Your Stakeholders

Working through distress requires a team approach. Cultivating stakeholder engagement, especially that of senior managers and employees, requires a communication strategy that conveys, at least in summary, the true condition of the business. The tone and content of the communication should be honest, inspire confidence, and prompt action.

We have found that a CEO too ashamed or afraid to do this may make matters worse. Your legal and restructuring advisors will help you develop an appropriate communication strategy.

Improve the Quality and Speed of Information

The development of a plan and its execution will be hobbled by inaccurate or slow financial reporting. With an honest and unemotional view, your advisors may suggest immediate fixes in your accounting department, to make sure you and they will have the information needed for real-time monitoring of the condition of the business and the effectiveness of turnaround measures.

In a normal business setting, not having accurate and timely reports is like flying a plane without instruments. In a distressed setting, it’s like flying without instruments through the mountains in a storm.

A turnaround plan should proceed on two parallel paths: a restructuring outside of bankruptcy; and preparation for a bankruptcy filing.

If the turnaround and stakeholder negotiations go well, the turnaround can proceed outside bankruptcy, and the preparations for bankruptcy will have been precautionary. However, if they do not go well, it is critical to be prepared for a quick voluntary filing or for an involuntary filing by angry creditors.

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Focus on Cash

You will watch actual and anticipated cash balances like a hawk, day to day, moment to moment, and do triage for what gets paid and when. Like a fuel gauge, rolling cash flow projections, with visibility to the next 13 weeks, is a mandatory turnaround tool.

Focus on the Income Statement

You will focus on the income statement with a critical assessment of what can be done to improve it.

• Can revenue be improved with more targeted marketing, added sales incentives, increased prices, focus on collections?

• Can margins be improved through negotiated price concessions with suppliers, compensation adjustments, reduced headcount, firing of unprofitable and difficult customers, elimination of unneeded expenses, or other items?

• Are there creative opportunities to generate revenue and spread risk, like licensing IP, joint ventures, contract manufacturing?

Focus on the Balance Sheet

The balance sheet may immediately reveal an existing problem or new problems likely to arise during distress. Start with the liabilities section. Be proactive and highly communicative with the bank and other major debt holders. Forewarn them of potential payment and covenant defaults. Resist being handed off to the special assets group.

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Restructuring in BankruptcyWhile creditor negotiations are underway, prepare for bankruptcy. Though you and your advisors will do everything possible to keep the company out of bankruptcy, you should anticipate the threat of an involuntary filing or other legal action by disgruntled creditors. A credible threat of a voluntary filing will be a sword to motivate cooperation for a pre-bankruptcy restructuring and a shield if cooperation fails.

Chapter 11 Reorganization

The US Bankruptcy code provides protection for insolvent companies to be sold, liquidated, or reorganized. Chapter 11 of the Code governs reorganizations.

Although a Chapter 11 case can be commenced by an involuntary filing by a company's creditors, this paper focuses on Chapter 11 proceedings initiated with a voluntary petition filed by the debtor. Chapter 11 proceedings include close court supervision, exhaustive disclosures and notices, presentation and negotiation of a reorganization plan, votes of creditors, court approval, and implementation of the approved plan (confirmation).

During the proceeding, the owners and managers of the business and assets of the company (the estate) will be allowed to continue to operate the company as a “debtor in possession” (DIP). As an initial matter, the DIP will need court approved access to cash that otherwise is subject to the claim of secured creditors (a cash collateral order) or must obtain new working capital financing (a DIP loan or DIP credit facility). The motion and hearing processes for cash collateral, approval of DIP financing, and the array of other issues to be resolved in a reorganization are expensive and time consuming. Chapter 11 cases take a number of months and can take years.

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In recent years,1 some companies have accelerated the Chapter 11 process through Section 363 of the Bankruptcy Code. Section 363 provides for asset sales outside the course of the debtor's business, which can occur relatively quickly after the bankruptcy filing. Such cases are often "pre-packaged" before a voluntary filing, with a restructuring plan largely negotiated and the company effectively "pre-sold." From filing to a 363 sale, the process can take only two to three months as compared to the many months or several years for a normal Chapter 11 reorganization.

The Bankruptcy Court may confirm a Chapter 11 restructuring plan agreed to by the creditors or force the restructuring (a cramdown) on the dissenters.

Section 363 Sales

For potential buyers of a company's assets, the real benefit of the Section 363 sale is a court-ordered transfer of the assets of the business "free and clear" of liens and claims.

While Section 363 planning generally occurs before a filing, it can also come after. In either event, it requires controlling shareholders to agree that more potential value will remain for all stakeholders if a plan can be consummated sooner than later. Senior secured creditors may also apply pressure for a sale.

The Section 363 sale process itself is akin to a traditional investment banking strategy to sell a business and its assets in a competitive auction, except Section 363 sales occur under court supervision, are subject to court hearings and approvals, and, as described above, result in assets being acquired free and clear of liens and claims.

If in the course of turnaround and workout negotiations, a Section 363 sale becomes a viable option, planning should start and a sale agreement should be negotiated to the fullest extent possible before the bankruptcy filing. Otherwise the process may be delayed by legal objections and long waits for court hearings and orders. 1 Many small businesses may qualify for a quicker and less expensive Chapter 11 track under

the Small Business Reorganization Act (SBRA) amended by the Coronavirus Aid, Relief and Economic Security Act (CARES Act). Under the SBRA, a “small business” is one with total debts of $2,725,625 or less. Under the CARES Act, this limit was lifted to $7.5 million for one year. After March 27, 2021, the limit will drop back to $2,725,625, unless extended by Congress.

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Here is a summary of the steps to be taken, immediately before and after the filing, as a debtor in possession:

• Preparation of sale package with supporting financial and other disclosures about the company, its business, and agreements with creditors.

• Drafting marketing materials to solicit interest of potential buyers.

• Selection of an initial bidder ("stalking horse").

• Negotiation of a tentative asset purchase agreement with the stalking horse bidder.

• Filing of a Motion for a court order approving a sale by auction and the rules to govern the sale.

o This motion will also seek approval of expense reimbursements for the stalking horse bidder's costs of motion preparation, due diligence, and documentation and breakup fees to offset the risk of being outbid by free-riders.

o The DIP may seek an expedited hearing in emergency circumstances.

o The auction rules will provide a short time (e.g., 30 days) for competing bidders to come forward and review due diligence materials.

• Notice to creditors and potential bidders of the court order, including the auction timing and procedures and deadline for submission of bids. Secured creditors may bid the amount of their secured claims (a "credit bid").

• Sale at auction held after the close of the period for the submission of bids. The debtor provides a report on the auction and details of the winning bid. If there are no bidders other than the stalking horse, the auction is cancelled and the stalking horse bid wins.

• Final Order of the court approving the sale and winning bid. At this point, if there are objecting parties, they will be allowed to present their arguments to the bankruptcy court. The debtor will reiterate its arguments supporting the necessity of a sale and compliance with the court-approved sale procedures. The court’s detailed findings on these points will protect the winning bidder’s purchase of the assets free and clear of liens and claims.

• Closing of the deal with the winning bidder then progresses and the proceeds of the sale are distributed as provided in the plan.

With good advice, careful planning, effective negotiations, and efficient execution, the Section 363 sale may be the best option to preserve and maintain value for all stakeholders.

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In conclusion . . .An effective and efficient turnaround and restructuring, in or out of bankruptcy, requires:

• Immediate and sound legal and restructuring advice;

• Careful but quick planning;

• Accurate and timely information;

• A credible and cohesive restructuring team;

• All-hands-on deck teamwork;

• Aggressive execution; and

• Optimism, hard work—and some luck.

If your business is in distress, Galena Capital is ready and willing to help.

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800 W Main Street, Suite 1460Boise, ID 83702208 853-5200

www.galenacapital.com

About Galena CapitalGalena Capital is an investment bank dedicated to serving businesses in the US Northwest. We are registered with the SEC and FINRA.

Jerry Sturgill208 850-5215

jerry@galenacapital.com

Bill Benjamin952 454-7665

bill@galenacapital.com

Juan Carlos Duque312 560-1218

jc@galenacapital.com

Experience During economic upcycles and downturns, we help middle-market companies with our deep transactional experience and combined backgrounds as investment bankers, business owners, CEOs, and legal advisors.

We are proud westerners and know how to do business here. We deliver highly-focused and highly-personalized services to help fellow business owners who, like we do, live and work here.

ResultsOur three partners have over 85 years of combined professional experience in the industries described below and completed transactions with a combined value of over $35 billion.

We know how to get results.

© 2020 Galena Capital Partners Inc.