Distressed Businesses: On the Road to Recovery

by Josephine Giordano, MBA, CPA, ABV, CFF, CFE, CBA, ASA, CDBV, CIRA, CICA

The Arizona economy and our local businesses are suffering significant distress in these uncertain times. A business’ going concern premise is compromised as growth and cashflows decline and risk increases. Financial distress is a condition in which a company or individual cannot generate revenue or income resulting in challenges in paying its financial obligations. This is generally due to high-fixed costs, illiquid assets or revenues sensitive to economic downturns. According to a report from the Federal Emergency Management Agency (FEMA), 40% of businesses do not reopen following a disaster, 25% fail within one year. The U.S. Small Business Administration found that over 90% of companies fail within two years of being struck by a disaster.

The long-term recovery of businesses can be affected by numerous factors, including the industry in which it operates, how long it has been in business and its financial health before a disaster or economic downturn. Although we cannot predict how long the road to recovery will take, we can take steps to overcome some obstacles along the way. Business Value and Premise of Going Concern

As businesses begin to reopen, particularly through a phased-in approach, additional challenges requiring attention will begin to emerge that could adversely affect the reinstated operations. Under a going concern premise, the business is assumed to continue operating going forward. Ultimately, that is the road we are diligently working toward. In moving in that direction, we need to address some of the specific company risks that typically exist for distressed businesses:

Key supplier dependence — Small companies typically depend on a single supplier for a product or service. Increased financial pressures could occur if key suppliers reduce credit terms and demand payment in full. Risks can be minimized by researching other suppliers and anticipating alternative credit arrangements.

Customer risk — Customer perception is paramount during the partial/ complete reopening of businesses, particularly individual consumers. Clearly delineating and communicating steps taken to keep consumers safe is crucial in mitigating concerns. For commercial customers, establishing strategic plans to address quality of product/service and continued reliability will help to reduce risk.

Workforce reduction risk — Crosstraining employees helps to alleviate the risk of decreased production or inconsistent quality of services provided.

Litigation risk — Litigation risk is typically heightened during distressed situations. Proactive legal consultation is prudent to assist in managing contingent liabilities/litigious claims.

Regulatory risk — Consider any proposed regulatory changes in the industry in which the business operates. Proposed changes could positively or negatively impact business operations.

Forecast bias — Strategic planning involves cashflow forecasting which could tend to be overly optimistic or overly pessimistic in uncertain times. Setting baseline expectations that are reasonable is challenging. Periodically

Business Valuation and Forensic & Litigation Services Virtual Conference November 20, 2020 Webcast Only Recommended CPE Credit: 8 Hours

Get up to speed on considerations, methodologies and rulings on a variety of business valuation, forensic accounting and litigation services topics. Join us for a day of informative, progressive and dynamic sessions on both subjects from national and local speakers. Current practitioners and those interested in knowing more about the practice are encouraged to attend.

Conference Agenda

The CPA’s Role in Distressed Business Litigation

Josephine Giordano, BeachFleischman PC

Economic Damages: Evaluating Reasonable Certainty and Causation When Calculating Lost Profits in COVID-19 Environment

Michael A. Fahlman, Berkeley Research Group, LLC

Testifying War Stories

Moderator: Brendan James Kennedy, ATLAS CPAs & Advisors PLLC Panelists: Lynton Kotzin, Kotzin Valuation Partners, LLC and Frank Pankow, Pankow Company, P.C.

Business Interruption Loss – Sniffing Out Misrepresentations

Michael Haugen, J.S. Held

Reports of CPA Litigation Experts – What Attorneys Are Looking for in Expert Reports and in Their Direct and Cross-Examination of Experts

Jeffrey G. Pollitt, Jeffrey G. Pollitt, P.C.

Capital Market Outlook – During and After the Pandemic

Michael J. Carlin, Henry+Horne Wealth Management

M&A COVID Effects

Moderator: Lance A. Meilech, IBG Fox & Fin Financial Group, LC Panelists: Jonathan Ariano, Kotzin Valuation Partners, LLC and Michael R. Metzler, Henry+Horne

Unique Aspects of Gift and Estate Tax Valuations Cindy Andresen, Kotzin Valuation Partners, LLC

Register online at www.ascpa.com/bvfl20 or call (602) 252-4144.

monitoring forecasts will help to minimize forecast variances.

Business Interruption and Lost Profits

There are numerous instances where business operations are interrupted that result in minimal impact. In other instances, for example, a building fire or major equipment failure, there may be long-term waiting periods in resuming operations. Companies attempt to mitigate these risks by establishing disaster recovery plans to address high-risk scenarios. It is generally recommended that business insurance policies be reviewed at least on an annual basis to ensure adequacy of coverage.

Fraud Deterrence and Detection

In a recent survey conducted by the Association of Certified Fraud Examiners, 90% of the anti-fraud professionals reported an increase in consumer scams due to COVID-19. Of those surveyed, 75% said they already have encountered an increase in phishing through government impersonation, and 71% report seeing an increase in charity fraud. They also have experienced an increase in fraudulent vaccines, cures or tests for the coronavirus (66%); third-party seller and buyer scams on legitimate online retail websites (64%); business email compromise scams (62%); and cyberbreaches (61%).

Analysts anticipate massive frauds on the horizon. Business owners/management should be educated about possible red flags and continue to provide oversight to even limited operations of a business.

Turnaround & Restructuring

Most businesses heading toward financial distress require detailed attention to addressing operating deficiencies as well as strategic changes to the structure of the business. Turnaround is typically used to mean the process of solving the operation problems of a business. Restructuring is typically used to mean the process of developing a financial structure that will provide the basis for turnaround.

There is approximately $10.1 trillion in corporate debt currently outstanding of which $934 billion is distressed, compared with $6.6 trillion in 2008, of which $184 billion was distressed.

During challenging economic times, management needs to develop strategies to safeguard assets and maximize cashflows. Options to consider include debt restructuring, sale of non-operating assets, and investment of new capital from outside sources.

Company management should consider a SWOT analysis pre-COVID-19 to assess the business’ strengths, weaknesses, opportunities and threats, and then consider the short- and long-term potential effects of COVID-19 on that analysis. What steps can be taken to mitigate risks? How can you leverage your strengths against the weaknesses? Businesses should consider creating a think tank of opportunities that could be initiated even in the short-term.

Bankruptcy Relief

The Small Business Reorganization Act of 2019 (“SBRA”), effective February 19, 2020, provides that a small business debtor may elect at the time of filing to proceed under a new Subchapter V of Chapter 11 of the Bankruptcy Code. The U.S. Trustee’s Office website provides details regarding the provisions of the new law, including the legal rights and duties of the debtor and other parties, and the new responsibilities of the United States Trustee.

The CARES Act temporarily raised the eligibility debt ceiling from $2,725,625 to $7.5 million for new cases filed between March 28, 2020 and March 27, 2021.

By simplifying the plan confirmation process, lowering costs, and raising the debt ceiling, SBRA can provide another option for small businesses seeking reorganization

Although we cannot predict the post-COVID future, preparing for the business challenges ahead is prudent and takes careful planning and perseverance. l

Josephine Giordano is a director in BeachFleischman’s Financial Forensics and Valuation Services Group. Giordano has extensive experience as a financial professional, with a diversified background that encompasses internal audit, banking, tax, business valuation, fraud investigation and forensic accounting, bankruptcy and restructuring, turnaround management, court-appointments and other litigation support services. Contact her at jgiordano@ beachfleischman.com or (602) 792-5981. Endnotes https://www.investopedia.com/terms/f/ financial_distress.asp 2 ACFE Insights, April 26, 2020. 3 St. Louis Fed; Bloomberg; New York Times; American Bankruptcy Institute’s webinar: Litigation Finance: Lessons from the Last Financial Crisis for the COVID-19 Downturn, May 6, 2020. 4 https://www.justice.gov/ust/file/sbra_legal_manual.pdf/download 5 https://www.natlawreview.com/article/ temporary-and-permanent-changes-made-tonew-small-business-reorganization-act-2019

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