Karen Kimel explores the complexities of the cash consideration component of liquidation proposals. In particular, she breaks down the numbers and offers the best approach when selecting a liquidator.
You can’t escape the headlines these days – major retailers in Canada are closing their doors at an alarming rate. Just a few months ago, Toys R Us announced it was closing 180 stores in the United States, and while Canadian stores haven’t followed suit, it’s hard to ignore the possibilities. That said, will Toys R Us join other ill-fated Canadian retailers such as Sears, Mexx, Tip Top, Jacob, and Target? Only time will tell, but these days even the largest and longest standing retail chains are among those being disrupted by changing consumer habits, gigantic box stores and online shopping.
In certain retail insolvencies, we have seen a shedding of the non-contributing stores and a going concern sales process around the profitable stores. In other insolvencies, it would seem that a complete liquidation of the inventory generates a better return to creditors than even a partial going concern sale.
Insolvency practitioners will typically seek proposals from the large retail liquidators, which typically follow a comparable format. This article focuses on the cash consideration component of liquidation proposals and, in particular, the calculation of the guaranteed amount after adjustments for penalties.
What does a liquidation proposal typically look like?
A typical liquidation proposal will include a guaranteed amount which is typically an agreed percentage of cost value of inventory. For example, a guaranteed amount of 80% of cost value where the cost value of inventory is $100MM would equate to a guaranteed amount of $80MM.
While a straight guaranteed amount would make it easy to compare proposals, most if not all proposals necessarily contain “adjustments” to the guaranteed amount which can only be calculated after the liquidation is completed. Understanding and analyzing these complexities prior to selecting a liquidator is key to making a well-informed decision.
Merchandise and cost factor penalties
The guaranteed amount is typically fixed based upon an agreed:
- inventory threshold
- cost value of inventory as a percentage of retail value of inventory
Penalty/adjustment schedules are appended to the liquidation proposal outlining the amount of adjustment to the guaranteed amount should the inventory threshold or cost factor be outside of the agreed range. These adjustments are reconciled on completion of the liquidation sale to determine the ultimate net payout by the liquidator.
In the above example, if
- the guaranteed amount was 80%
- the agreed inventory threshold was $90MM – $100MM
- there was a 0.2% downward adjustment for every $1MM above/below the threshold
A final inventory amount of $103MM would result in a reduction of the guaranteed amount, to 79.4%. The same calculations to reduce the guaranteed amount would be done after assessing the cost value of the merchandise as a percent of retail value with its agreed thresholds.
The above penalties are normally independent and cumulative, so in the case that both scenarios occur i.e., inventory above the threshold amount and cost to retail value above the agreed threshold, the guaranteed percentage would fall by both adjustments cumulatively.
Management, creditors and their advisors should prepare models that compare liquidator proposals under a multitude of scenarios
Analyzing these adjustment schedules can be difficult since each liquidator may provide changing adjustment amounts at varying intervals. As a result, trying to compare each proposal on an apples-to-apples basis can be tricky, but is ultimately important to making a well-informed decision in choosing the right liquidator. Of course, other factors also need to be considered such as the liquidator’s track-record and proficiency in handling sales of similar scale, financial security in form of letter of credit or otherwise, and sharing of upside should guaranteed targets be exceeded.
Ideally, a data table is created for each liquidation proposal under various realization scenarios. A heatmap which then compares the data tables of each proposal can then be prepared in order to provide stakeholders with a clear view of the circumstances under which each proposal may be advantageous over another. Below is an illustrative example of a heatmap, without quantitative values, comparing liquidator A to liquidator B under a range of inventory and cost to retail value of inventory scenarios:
Informed decisions will yield the greatest results
Understanding and analyzing the complexities of retail liquidation proposals—prior to selecting a liquidator—is key to making a well-informed decision.
In the case of Toys R Us Canada, it’s a wait-and-see approach. Will they follow the all too familiar footsteps of recently bankrupt Canadian retailers, or will they survive the turbulence? Stay tuned.
However—for companies facing impending liquidation—the type of analysis mentioned above is both highly beneficial and recommended. Having data tables and heatmaps can go a long way to understanding the details of liquidation proposals, and ultimately making the best decision for your stakeholder group.
Karen Kimel is a Managing Director with the Restructuring group, and she is the co-leader of the Business Modelling & Analytics team at Farber. Karen can be reached at 647.796.6022 and firstname.lastname@example.org.