Breaking the Fall: How to Approach a Failed Business Plan
- Feb 03, 2016
When things go wrong—whether it be with a tenant, a vendor, a capital partner or your own pro forma assumptions—recognizing the signals of an impending train wreck and developing a plan to minimize the impact are important qualities of a good real estate team.
The ability to see early warning signs starts with good asset management and property/project management. What can your team do when a tenant rent default occurs, a construction project is delayed, leasing projections are not met or a partner incurs debts or is involved in a lawsuit? Monthly reports can provide early warning signs, and asset managers need to be alert to missed projections and defaults. Property managers and brokers must also be alert to unplanned key management changes in a counterparty and report developments to portfolio and asset managers.
Having recently been involved in such a situation, I believe good legal counsel is important to an action plan. Legal counsel can revisit or prepare lease and partnership agreement abstracts to ensure the contract/agreement includes the remedies you need and to understand potential default triggers. Legal counsel should also perform asset and title searches to look at unexplained liens on a partner’s residence or other business assets, as this signals financial stress.
You should also bring in a team with a variety of backgrounds, including bankruptcy expertise to analyze potential asset transfers between affiliated entities without fair value or preferential payments to creditors; litigation expertise to analyze that involving a vendor or partner; and corporate expertise to review private offerings a partner may have issued. If brokers aren’t getting deals to a project but market dynamics are strong, ask questions, run numbers on the impact of a default or failure, and consider what notices need to be given to the project’s lender, if any.
Financial stress situations are often a sign cash flow is being diverted to pay creditors other than those your counterparty is required to pay under the contract. You’ll need to determine whether throwing cash into the situation—through additional loans/advances, abated rent, replacing a vendor with a higher-priced provider or some other cash infusion—is the wiser move, or is it merely throwing good cash after bad? Developing that plan with a full legal audit of documents and potential remedies and risks is a key component to the determination, and provides some protection if someone goes back looking to show wrongful conduct.
In most cases, there is a way to “break the fall”—or develop a plan preventing the diversion of cash flow to pay debts unrelated to the project, required investment or affected business—or to implement a forbearance that buys time in exchange for certain controls over the counterparty’s actions.
This year seems to be the time when certain bubbles are bursting—not on a macro level, but in specific verticals: Some retail operators had a weak holiday season; some tech sectors are retrenching and valuations of later-stage companies are going down; and some venture capital companies are redirecting their investment portfolios and reconsidering their positions in portfolio companies. Getting regular monthly reports from your property managers and development partners is a key component to catching issues early, as the lines of communication with a counterparty or partner are still open, and you can ask for sources and uses of funds, quarterly projections on gross sales or capital raise projections.
Breaking a fall is only possible if you have a plan and the ability to be nimble when plans need to change.