The importance of viability assessments — for both creditors and debtors

2021-12-06   minute read

Paul Pettigrew

Both parties in a creditor-debtor relationship benefit from clear communication, mutual respect, and a shared understanding of the facts. Viability assessments are one tool for achieving that.

Viability assessments — also known as business reviews or “look-sees” — are consulting engagements generally initiated by a secured lender, to obtain an independent assessment of the debtor’s financial position, operations, and future business prospects. The debtor typically is experiencing financial difficulties, has defaulted on payments, or otherwise breached covenants, and may be asked to hire a third party to perform a viability assessment.

Viability assessments are a means of “looking under the hood” of an organization to spot issues that are not always obvious on the surface.

Understandably, these engagements are usually initiated by the lender and are seen as being exclusively for the lender’s benefit. However, some little-known facts about viability assessments show that the debtor can stand to benefit from the engagement as well.

The scope of work can vary

The extent and nature of viability assessments depends on the lender’s concerns and can be very limited and focused or broad and expansive. Scope items may include:

  • Security position review – assessing and estimating the net realizable of the underlying assets covered by lender’s security, net of priority payables, a prior ranking secured debt, realization costs, etc.
  • Limited security position review – assessing and estimating the net realizable value or other issues of concern relating to a specific category of the underlying assets covered by lender’s security (e.g. collectability of accounts receivable, realizable value of the inventory)
  • Compliance and accuracy of borrowing base/margin reporting – This may include an evaluation of priority payables against the credit facilities’ terms
  • Business viability – reviewing and assessing the debtor company’s past, current, and projected future financial performance, which would include a detailed review of the debtor company’s financial projections, operational restructuring plans, etc. for reasonableness or plausibility
  • Limited business viability – limited to reviewing financial projections
  • Such other matters the lender may consider important or necessary (e.g. reviewing and assessing the near term liquidity of the debtor company)

Even if the creditor is the one to request the viability assessment, the cost of the engagement may be borne by the debtor. For a company that is already cost-conscious or in financial distress, adding another expense can seem burdensome.

Some potential good news if you’re a debtor is that the scope of work can be limited or targeted, as shown above. It’s not an “all or nothing” engagement and can be tailored to the situation and budgetary concerns.

They can benefit the debtor

The third party hired to perform the viability assessment can provide not only a picture of what the financial health of the company is, but also some advice on how to make improvements. The assessment, therefore, can be an opportunity to gain new insight into the borrower’s business.

Consultants who perform viability assessments can bring a myriad of experience, having “looked under the hood” of many companies, including some in the same industry. They have their own data and metrics, may have insight on what competitors across the country are doing, and what industry standards are. Operational improvements may be discovered during the course of the engagement.

In the end, the third party performing the assessment wants to be to a trusted advisor to both the lender and the borrower. Debtors may end up getting more than they paid for, in a good way.

Lenders are not the only ones who ask

Although they have access to all the right internal data, management, owners, and executives of a company often are too close to the issues to maintain objectivity.

Sometimes a stakeholder like a shareholder will request a “look-see” if they have concerns regarding their investment.

But more importantly, a viability assessment can also be initiated by a debtor. They may be experiencing financial difficulties and want to gain insights on how to improve efficiency or profitability. They may ask to have it completed prior to approaching a lender, so everyone is on the same page during negotiations.

Having an objective and honest third party review the financial health of the business will prove beneficial in many situations, not just for the purpose of appeasing a lender.

They can help maintain good business relationships

Lenders and borrowers may sit on opposite sides of the negotiating table, but there is usually no reason the relationship between the two needs to be adversarial.

Viability assessments are known to improve communication between borrowers and the lenders. The report at the end of a viability assessment goes to both parties; it can provide a shared set of facts that lowers the risk of misunderstandings.

Also, if the result of a viability assessment is that the debtor’s financial situation is not as bad as it seems, or can be improved over time, the creditor’s mind can be put at ease.

Under most agreements, if a debtor refuses to have a viability assessment done, the creditor can make it happen through other means. This can result in damaged relationships and may lead to a formal insolvency proceeding (receivership or bankruptcy), which both parties would want to avoid under ideal circumstances.

In conclusion

For these reasons, debtors may be reluctant to hire an outside consultant for a viability assessment at first, but often come out of the experience seeing the benefits they drew from it. It gives an honest and objective assessment of where they are at, and in some cases advice on how to improve.

MNP has profound experience not only in performing viability assessments, but also in consulting businesses on how to improve all facets of their operations. Sometimes the two go hand in hand.