Chapter 11 reorganization, which allows financially distressed companies the opportunity to restructure liabilities and emerge as a viable going concern, can be a chaotic and challenging time for the company. For management teams working through a bankruptcy, there are a number of valuation-related considerations. Here are five key concepts for management teams and their advisors to be familiar with when embarking upon a Chapter 11 reorganization.
- Liquation vs. Reorganization. The proposed reorganization plan must establish a “reorganization value” that provides superior outcomes for shareholders relative to a Chapter 7 liquidation proceeding.
- Liquidation Value. This premise of value assumes the sale of all of the company’s assets within a short period of time. Different types of assets might be assigned different levels of discounts (or haircuts) based upon their ease of disposal.
- Reorganization Value. As noted in ASC 852, Reorganizations, reorganization value “generally approximates the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring.” Reorganization values are typically based on discounted cash flow (DCF) analyses.
- Cash-Flow Test. A cash-flow test examines the viability of a reorganization plan, and should be performed in order to determine the solvency of future operations. In practice, this test involves projecting future payments to creditors and other cash flow requirements including investments in working capital and capital expenditures.
- Fresh-Start Accounting. Upon emergence from bankruptcy, fresh-start accounting may be required to allocate a portion of the reorganization value to specific identifiable intangible assets such as tradename, technology, or customer relationships. Fair value measurement of these assets typically requires use of the multi-period excess earnings method or other techniques often used in purchase price allocations following a business combination.
For a more in-depth discussion of these concepts, we invite you to check out the article “Valuation Expertise: Necessary Chapter 11 Process Navigation” in the October 2014 issue of ABF Journal. This article was written by Mercer Capital’s Travis Harms, CFA, CPA/ABV and Sujan Rajbhandary, CFA. Mercer Capital has assisted numerous clients in developing and defending both reorganization values and identifiable intangible assets in the context of corporate bankruptcy. Give one of our professionals a call today to discuss your needs in confidence.