Fund Crisis and Change Management: A Fresh Approach
Published in International Corporate Rescue Magazine 2015:
Samantha Wood, Manager, KRyS Global, Cayman Islands
Since the 2008 global financial crisis, some directors and managers of financial services companies, hedge funds and investment vehicles, have struggled to address the fall-out from the recession, and may still be facing financial uncertainties. Traditional solutions, such as voluntary and compulsory liquidations, have historically been employed to deal with structural or financial difficulties with varying degrees of success.
Further, fund managers may at times find themselves faced with the question of what to do when an offshore fund has run its course, the strategy and objectives have shifted, or its economics are no longer consistent with investment objectives.
It can be tempting to ignore warning signs or put off making changes that are needed. However, ignoring the problem will rarely, if ever, result in maximising value for investors, and may even cause problems in healthy parts of the business if left unchecked for too long. So what options could fund management considering these circumstances?
Traditional liquidation solutions – not fit for purpose
The liquidation process is a formal one, which does not necessarily address situations where changes are needed. As a liquidator’s role is laid down in law or directed pursuant to a court order, there is little flexibility in what steps they can take and what potential solutions can be explored, as well as adding additional layers of cost. Sometimes the burden of conducting the statutory requirements of a liquidation can far exceed the benefit achieved from the work done to address the problem. As a result, the liquidation process is often ill-suited to address the unique challenges facing funds.
Investment managers and office holders may also be concerned about loss of control in a liquidation scenario. These stakeholders, who are more familiar with the fund, its investments and affairs, may find themselves and their knowledge pushed out of the process, while costs pile up and they see investments sold at significant discounts. This results in strained relationships between the stakeholders and liquidators and a loss of operational knowledge in winding up the company’s affairs.
In addition, because the liquidation process is a formal open process, the entity’s professional service providers can face stigma through association, albeit unfairly, creating reputational and credibility issues for years to come, particularly where parts of a business will continue to operate long after a specific piece or segment of the fund operation is wound-down.
However, there is an alternative solution for fund entities, which is internal to the company and with none of the stigma or reputational risks associated with
An in-house solution – Chief Transition Officer
A successful transition from an under-performing or distressed entity to one that is performing, or one where a specific problem has been addressed, usually requires management to drive operational as well as financial restructuring. However, management teams may be time constrained, particularly in a distressed situation, and not have the skills readily available within their organisation to implement a restructuring or transition plan.
Where management are lacking these skills, the appointment of a specialist onto the Board as a Chief Transition Officer (‘CTO’), or Chief Restructuring Officer (‘CRO’), can provide additional experience and flexibility to the management team, while allowing management to focus on running the business. Such a professional will generally have direct relevant experience of dealing with portfolios holding distressed or illiquid assets and can develop creative approaches
and solutions where a standard tool kit just does not fit. Fund managers will generally not possess the same skills and expertise as a restructuring professional, therefore they may inadvertently not identify or have the skills to implement the most effective plan without expert guidance.
The most practical and effective way to restructure or wind-down a fund is to leverage the knowledge and experience of the professionals who have been working with the fund historically, under the guidance of an experienced professional in the field of restructuring and distressed assets, who has alternative but complimentary skills to those of fund management.
In addition, absent fraud or insolvency, investment manager and director led restructurings or wind downs are often preferred by investors, provided that investors Fund Crisis and Change Management: A Fresh Approach have trust and confidence in the process. Therefore the introduction of a CTO to the fund’s Board, can instil trust and confidence in investors in relation to the proposed restructuring or wind down put forward by management, which will be critical to the success of the fund’s transition.
A CTO will first assist fund management in evaluating and analysing the fund’s situation, offering a seasoned perspective and enabling management to assess the seriousness of the situation. They will then evaluate the options and help management make a realistic and commercial determination of whether or not the problem can be addressed and a plan implemented to deal with the issue( s). Whether a restructure of the business or wind-down of the unnecessary or underperforming parts of the financial structure.
If there is a workable solution identified, the CTO will work closely with management in a practical and supportive way, to undertake the measures necessary to deal with the issue(s) and implement the plan, most often functioning as an ‘organisational medic’ who will handle the matter with the particular urgency, freedom and quite often, practicality that is required.
The level of the CTO’s involvement in implementing a plan will vary on a case by case basis, although as an officer of the company, the CTO tends to be relatively ‘hands-on’ with regard to the situation needing to be addressed. Nonetheless, as a restructuring professional the CTO understands the operational complexities of managing a fund through this process, and that this
must be balanced with an efficient work plan, agreed in advance, with clear delineation of duties.
For example, the investment manager will clearly be best placed to continue in the role of managing fund assets, while the restructuring professional is likely to take on the role of strategic oversight of operations specific to the implementation of the plan. Some roles, such as investor communications, will be agreed on a case by case basis.
The CTO will continue to remain in office until the identified issues have been resolved. Typically this will be in the region of 3 to 18 months. Alternatively, the ultimate aim may be a soft wind-down of the company or a more formal process, all of which would be agreed and discussed in advance with management.
As outlined above, a CTO brings additional experience and flexibility to the management team, allowing management to focus on running the business.
More specifically, the CTO will bring a number of other benefits to the fund:
The CTO will bring a wealth of relevant industry knowledge gained through years of experience, often in the restructuring industry. ACTO will recognise areas where the fund entity or its directors may be exposed to risk, particularly where there are solvency concerns or threat of litigation. Management are not always adept in taking swift action to prevent ongoing losses or will properly investigate all assets and liabilities of the fund, particularly when they are fire-fighting in a crisis situation. Potential areas of risk for office holders and service providers in such situations include fraudulent conveyances, preferences and director liability.
Further, because CTOs have a wealth of experience in troubled situations, they will have a unique perspective in finding solutions. A CTO will be able to identify flexible solutions to deal with the issue in hand, and given their experience, will also have the negotiation skills and temperament needed to leverage the fund’s position and ensure access to solutions it may not otherwise have available. In addition, the CTO may have access to other professionals and tools that are directed to the challenges faced by the fund.
For example, it may not always be necessary to wind-down all fund operations – CTOs with restructuring experience are skilled in identifying and segregating the underperforming parts of a business and experienced in structuring a hive-off of particular assets. Schemes of Arrangement are a particularly useful tool available, which can be utilised to isolate and creatively restructure parts of a business. Mechanisms, such as liquidating trusts to quarantine illiquid assets are also useful to allow that part of the entity to be wound-down more efficiently and quickly than it might otherwise be.
In addition, funds experiencing distress or crisis need to proactively manage their stakeholders, which include lenders, stockholders, other debtors, customers, service providers, creditors, lawyers and insolvency experts etc. Ensuring those stakeholders receive appropriate information and messages at the right time, is critical to securing their ongoing support and their agreement to the implementation of a workable restructuring plan. A CTO is adept at managing
stakeholders in a variety of difficult situations and will be able to speak to the various stakeholder groups in ‘their own language’, thus providing the fund with the very best chance of achieving a workable outcome to resolve the issue and get the fund back on track.
While providing support to management during the implementation of a plan, the CTO’s presence also gives stakeholders a high degree of reassurance that the management team has independent professionals backing the proposed plan. The CTO must exude a quiet confidence that will be a source of strength for all stakeholders affected by the issue at hand and provide reassurance to those stakeholders that the turbulent issue will be resolved, one way or another. The CTO will therefore be able to effectively manage emergencies and business challenges, while maintaining a high degree of professional composure and integrity.
Further, the CTO’s appointment to the Board means they are in a position to make difficult decisions that a fund manager may not want to make for political or reputational reasons. Being a step removed from the operating business, gives them a degree of impartiality and authority that those involved in the day to day business may struggle to convey. CTOs with restructuring experience will also be skilled in maximising value for the fund and developing effective realisation strategies, all of which will be conducted through proper processes, giving stakeholders and the market trust in the process. The appointment of experienced independent fiduciaries, also demonstrates a level of independence and transparency.
While it is clear that a fee will be charged for the service provided, a CTO will understand the commercial realities of a wind-down/restructuring plan, particularly where there are liquidity issues, and be sensitive to the need to devise a strategy that is flexible enough to enable asset realisations over an agreed timeline, which maximises value and is cost effective.
As such, a creative and flexible fee structure which is aligned with investor interests can be agreed when engaging a CTO, such as deferred payments payable on completion of strategic objectives, a percentage basis of realisations/distributions, fixed fee, or combination.
This also applies to funding of a proposed plan; the CTO will have relationships with potential funders, which could involve the use of creative and attractive mechanisms to address liquidity concerns i.e. agreements can be structured to provide funders with priority returns, contingent fees based on recoveries, or interest on funds advanced.
The restructuring professional will also have oversight of all service providers and processes, and will work with management to identify any inefficiencies or excessive expenses and address them swiftly, with a view to achieving cost savings, as well as any changes required as a result of the restructuring or wind-down plan.
When a fund faces challenges, such as liquidity concerns or threat of litigation, by engaging a CTO, the fund will benefit from a professional with the experience and skills to address the problem and minimise the risk of further litigation or claims against the fund.
A CTO provides management with a unique perspective on the problem or concern, and can assist the fund in finding an exit without the stigma or lack of control that would occur if a liquidation process was employed.