Exploring the Special Situations Dual-Track Transaction Process
Atlanta, GA — In the realm of corporate finance, the concept of a dual-track transaction process has been applied to three types of transactions, each quite different in the specifics, but all with an eye toward improving optionality, fostering competition, and minimizing risk of failure. The first, the traditional process, is a popular alternative often employed by growing companies competing in high-growth end markets. The second, the bankruptcy process, is a decidedly unpopular option of last resort for larger, over-leveraged companies that have taken on too much debt and need to raise the white flag.
The third, the special situations dual-track process, is the most relevant for middle market companies and their private credit lenders in a market where rapid interest rate increases, inflationary pressures, and a mixed bag of end-market drivers have created challenging refinancing conditions for some issuers.
The First & Second Options
The traditional dual-track transaction process — or at least the one most market participants enjoy discussing and taking part in — is the process in which a company and its advisors pursue, on parallel tracks, a public listing and an outright sale. What’s the point? To play the private and public markets off one another to create competitive tension to achieve the highest valuation for the current investors.
Among bankruptcy practitioners, however, the term “dual track” can bring to mind the “toggle” plan of reorganization. In this bankruptcy dual-track process, the toggle plan allows for the debtor to run a sale process while also pursuing a standalone reorganization. The bankruptcy version, of course, has a hugely different use case from the traditional version. While the bankruptcy version can sometimes create or enhance competitive tension across the two tracks, that benefit is muted by the enhanced disclosure requirements of a courtoverseen transaction and the multinodal decision-making required of bankruptcy voting. Rather, the primary pros of such a process are, one, to minimize the potential delays and costs of objections from out-of-the-money constituents and, two, to encourage junior stakeholders and holdouts to consensually resolve objections.
Coordinating the solicitation of preliminary market feedback requires careful planning by the advisor as well because potential strategic buyers, financial investors, and financing parties all operate on different timelines. With the benefit of that preliminary market feedback, sponsor, management, and lenders can choose a path at that juncture if one option is clearly the most superior.
The Special Situations Dual-Track Process Explained
The special situations dual-track process combines key characteristics of both the traditional and bankruptcy versions — perhaps it is the love child in a rocky relationship. The issuer in question is neither high growth nor excessively over-levered — the value of the equity in excess of the debt is not perfectly clear, but the risk of insolvency is generally low. As such, the issuer, with the assistance of its advisors, can credibly pursue a refinancing transaction while also marketing itself for sale to potential acquirers. Like its traditional relative, this transaction often creates multiple alternatives on each track, which in turn enhances competitive tension across the board. Like its bankruptcy relative, this transaction is often precipitated by lender pressure to derisk their position, perhaps as a result of lenders’ unwillingness to entertain further amendment relief or a sponsor’s reluctance to commit additional capital.
Despite these commonalities, the special situations dual-track process falls far from the tree in crucial ways. The outcome of the traditional and bankruptcy dual-track transactions both require a clear choice from constituents — it is one option or the other. A company cannot secure a public listing and sell to a single buyer — a debtor must either reorganize or sell.
However, a clear and important distinction lies in the special situations version this is the only dual-track process that is not necessarily binary, leading to an either/or outcome. With the traditional and bankruptcy routes, there is one or the other — the equity is clearly in the money or out of the money. However, in special situations, that factor remains to be seen at the outset — creating deeper complexity and requiring more careful planning and strategy at each step.
Optionality Is the Focus
While the primary focus of the traditional dual track is maximizing the current value as it stands at the time, and that of the bankruptcy version to derisk transaction execution, in the special situations option, enhancing optionality for all stakeholders — amidst ongoing uncertainty — is the primary focus.
Particularly in the current interest rate environment, common complications like a poorly integrated acquisition or even a slower-than-anticipated new product rollout often create covenant compliance issues, squeeze liquidity, or both, thereby exacerbating operational issues and negatively impacting the company’s (and sponsor’s) relationship with the lenders.
Rather than burying one’s head in the sand (as an issuer) or hitting the panic button (as a lender) a parallel exploration of sale and financing alternatives in collaboration addresses both counterparties’ concerns, thereby fostering a constructive dialogue in an otherwise difficult period. While any marketing process takes the management team’s attention away from running the business — ideally minimally with the help of skilled advisors — its role in each process is largely the same, so management’s input produces tremendous leverage. The advisor’s tailoring of marketing materials, messaging, and diligence information — all different depending on each type of prospective investor — ensures an orderly and robust process.
Coordinating the solicitation of preliminary market feedback requires careful planning by the advisor as well because potential strategic buyers, financial investors, and financing parties all operate on different timelines. With the benefit of that preliminary market feedback, sponsor, management, and lenders can choose a path at that juncture if one option is clearly the most superior. This decision point is one that the special situations dual-track process shares with the traditional and bankruptcy versions. Critically, however, in this version, at this initial process checkpoint, the preliminary market feedback can and often does reset the discussion among constituents. With actionable third-party alternatives more clearly on display, the constituents, whose partnership runs the risk of partition ahead of and on terms inconsistent with previous expectations, can now engage in a concrete dialogue where all may make contributions and concessions not previously contemplated. The odds of crafting a solution satisfactory to all increase substantially.
Short of a kumbaya moment, however, the process can also continue down one track — or both — with the added benefit of much clearer objectives. A straight sale or a full refinancing may still be the ultimate outcome, but again, in contrast to the other varieties, the outcome is very often more nuanced. In a partial sale, perhaps of a division or a segment, the proceeds may satisfy the lenders’ requirements to roll their remaining exposure or prompt the sponsor to revisit making an additional equity contribution. Similarly, a new junior capital raise or creative asset-based financing of previously overlooked collateral may lead to another transaction structure that bridges to a full refinancing or a more favorable M&A environment.
A Fairytale Ending
A dual-path capital markets transaction process, irrespective of the version, has more moving parts and requires greater resources than a single-track solution. Whatever the circumstances or the goals of the parties involved may be, the decision to commence on a dual path means, by default, that uncertainty is high, there is significant disagreement among constituents, or both.
When capital markets are strong and the outlook promising, the traditional dual path addresses high quality problems. The bankruptcy dual path, most prevalent during economic troughs, almost always leaves some parties aggrieved. The special situations dual-track process, when properly executed, stands the best chance of leading to a positive outcome or creating a bridge solution that addresses difficult problems and is supported by all involved.
If a company’s outlook, as well as market conditions, are neither too hot nor too cold, the special situations dual track may be just right.
Original article published in TMA’s Journal of Corporate Renewal.
About Rory Keenan
Rory has over twenty years of investment banking and credit advisory experience in the middle market.
Prior to joining Configure, Rory held senior positions at Jefferies, Solomon Partners, UBS and Raymond James. Over the course of his career, Rory has advised management teams, directors, creditors, buyers and other stakeholders of highly levered companies in need of creative financing solutions. He has executed advisory transactions including private and public debt and equity financings, exchanges, mergers and restructurings. Rory has extensive in-court and out-of-court restructuring experience.
Rory received a BA from the College of The Holy Cross and is a FINRA General Securities Registered Representative (Series 7, 63).