In rocket science, guidance maneuvers that employ engine thrust to slow or steer a rocket are often said to have made use of a “controlled burn.” While retail liquidations are certainly not rocket science, many small retailers could benefit from the use of a “controlled burn” of their own to slow down and steer a liquidation to a safer landing. Because many small retail liquidations are triggered by poor planning, waiting until the last minute, and then filing for bankruptcy, these retailers often crash and burn in Chapter 7 when alternative strategies could have produced better results.
A recent article in this magazine stated that 47 percent of retailers filing bankruptcy wind up liquidating.1 Stressing the need for proper planning, the article suggests that, at best, retailers may have three or four months in Chapter 11 before liquidation becomes inevitable. Smaller retailers may have even less time in Chapter 11 before liquidation becomes unavoidable, so they should consider other options before filing bankruptcy.
This article reviews key challenges retailers and their creditors face and suggests a controlled, coordinated approach—a “controlled burn,” so to speak—to maximize recoveries from a planned liquidation. To address these challenges directly, the following steps should be considered by retailers, liquidation consultants, and financial advisors in planning a small retail liquidation:
If the retailer has given up and turned over the keys, the secured creditor has given up on the retailer, or fraud is suspected and appointment of a fiduciary is critical, there are four fiduciary options to consider and evaluate.
Receivership. Often, a secured creditor moves for the appointment of a receiver to implement a quick change in control to steer the liquidation process. Unfortunately, the appointment may not be as effective for a short-term, 60-day liquidation plan and may violate the terms of the lease. In addition, a state court receiver may not have authority over assets located out of state.
Assignment for Benefit of Creditors (ABC). Generally viewed as the most cost-effective fiduciary appointment, an ABC can be effective for placing assets quickly under an independent fiduciary’s control and out of the reach of any judgment creditors during the liquidation process. This is a quick, effective remedy, but the procedures vary by state.
Chapter 7 Bankruptcy. Filing bankruptcy results in imposition of the automatic stay on any litigation and stops landlord evictions. However, the appointment of a Chapter 7 trustee will likely delay the liquidation by a minimum of 60 days, during which the trustee develops a liquidation plan and obtains court approval for the plan. During this window, administrative rent continues to accrue, credit card companies and landlords may refuse to cooperate, and utilities and alarms may be cut off, resulting in heightened risks to the inventory. Also, the secured creditor may decline to front the costs to move and consolidate inventory, particularly if there are no funds in the estate.
While often appropriate or necessary, filing a Chapter 7 can be costly because the trustee needs time to get up to speed and confront the transactional costs of putting the liquidation plan into effect.
Chapter 11 Bankruptcy. Chapter 11 leaves the retailer in control, but it can be costly and complex to steer the liquidation through a court process with the added expense of a creditors’ committee. Chapter 11 is generally intended for more complex cases in which businesses have some hope for survival.
If appointment of a fiduciary is not a necessity, the retailer should develop a plan with advisors to liquidate by executing a controlled burn strategy. A number of factors that will affect the strategy and ultimately the recovery should be considered, including:
Once the decision has been made to liquidate, operational planning begins with an experienced liquidation management team to assist in determining the best course of action to monetize the inventory assets. When assessing the benefits of both conventional and alternative liquidation strategies, including efficacy of the controlled burn strategy, it is prudent for small chain retailers to develop a comprehensive plan based on what is necessary to resolve the challenges specific to the retailer. What works well for large retailers may simply not be an effective strategy for smaller chains, particularly when considering potentially prohibitive cost factors, such as high store rental rates and labor costs, combined with low inventory levels of merchandise available to sell at individual store locations.
Under the controlled burn strategy, when bankruptcy is averted, retailers and their advisors have more leverage early when offering to work with key stakeholders, especially when:
For a liquidation to be effective, a realistic assessment of projected sales volume compared to the amount of inventory to be liquidated must be performed to ensure a sufficient sale length and an optimal store mix. In an ideal scenario, enough inventory will be available at each store location or can be reallocated through the stores to support an effective liquidation cycle.
It is not uncommon to strategically pare back the number of stores and consolidate inventory during a liquidation. Even considering the required expenses to do so, small chain retailers may find that shuttering select stores immediately to reduce expenses and consolidating inventory into fewer select locations before launching the liquidation sales will lead to a higher net recovery.
When determining the optimal store and inventory mix, it is prudent to comprehensively review:
Whenever possible, the schedule for the liquidation sale should be neither rushed nor stretched. Organizing the launch and duration of the sale around a predetermined period will yield the most favorable results, particularly when the sale launch and markdowns are timed around holidays or local events that capture a natural surge in customer traffic. In the controlled burn strategy, advisors assist in addressing the benefits of proper timing early with key stakeholders. This should lead to consensus with the strategy and avoid negative influences that affect the net recovery, such as landlords wanting to push a retailer out, forcing the sale to be accelerated.
Small chain retailers are not as well branded as their larger counterparts, so they do not typically garner recognition and publicity from media sources. Because marketing budgets are generally tight, employing social media channels to create viral awareness and customer interaction is imperative. Additional, less expensive marketing techniques, including store signage and email marketing, may generate more cost-effective results early in the sale, particularly when executed in conjunction with an effective pricing and markdown strategy. As awareness builds, omnipresent channels, such as television and radio advertising, can be incorporated if the cost and projected results scale effectively.
Furniture, fixtures, and equipment (FF&E) can be used during the liquidation and subsequently sold or auctioned at the individual sale locations, or secondarily, buyers of used FF&E can be targeted directly. Because FF&E is often specific to a retailer, demand for the items is not always high. The recent increase in retail store closings has also pushed a surplus of retail-related FF&E into the marketplace, negatively affecting prices.
Effectively unwinding a small chain retailer requires professional services, and significant expenses can accrue during a liquidation process. However, filing bankruptcy without sufficiently reviewing alternative options beforehand may cause smaller chain retailers and their key stakeholders to unnecessarily leave money on the table. When staying out of bankruptcy and preservation of capital are the goals, the controlled burn approach presents a comprehensive, creative, and malleable strategy designed to make professional advisory and liquidation planning services available to smaller retailers in need of effective monetization services.