Troubled Companies

The following text has been prepared by Arthur Lipper III for British Far East Holdings Ltd. and is intended to be part of a book, “Troubled Companies”. No reproduction or publication of these writings is authorized, except with written consent of the author and owner.

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Chapter 8

Dealing with executives and staff in Troubled Companies

There is a significant area of conflict and problem when owners of troubled companies use stock or stock options to recruit or retain executives or other staff members.

The issue is what is really being offered the individual, who, at least in part, is being asked to accept a share in the profit or assets of the enterprise when those having invested in the company have nothing but losses to show for their investment.

In one company I know the investors had invested more than $24 million with the current value of the company being about $5.0 million. The investors had used preferred stock and convertible debentures as the securities through which to invest.

The company had a stock option program and made periodic awards to all levels of employees and used stock options to attract senior executives and consultants. The stock options were used as a partial cash substitute. In my case, I was asked to take a 40% reduction in my normal monthly retainer, accepting shares as a substitute.

The problem is defining that which is really being offered. In the case of this particular company nothing was being offered as the feeling of the controlling investor was that as long as they had losses there shouldn't be profits for others. "How can they expect to profit when we have losses?" was the question proposed to me. The answer, equally logical, is "How can it be expected that someone coming into a company now, which is worth only $5.0 million, and be expected to wait until the company is worth $24 million before deriving any benefit from the company's progress?" It doesn't make sense.

The problem is one of the controlling shareholder not being willing to recognize the $19 million of loses as having occurred and the value of the company being but $5.0 million. An unwillingness to accept loss recognition by investors in private companies is major problem.

Perhaps a fair basis for pricing stock options might be at say 80% of appraised value with a periodic revaluation of exercise price. The time when controlling shareholders should want the exercise of employee stock options most is when the company has problems and the valuation of the company is relatively low. It is more important for the company to have increased employee financial participation during periods of stress than of prosperity. Therefore it is logical companies make it attractive for employees and associates to buy stock when there are problems.

Of course, the issue is that in most cases employees only are able to exercise stock options when the stock is worth or selling considerably above the exercise price of the option. Therefore the company, in times of duress, might have to allow the exercise of the stock options with debt of the option holder, perhaps to be payroll or fee deducted.

The issues, from the perspectives of both existing equity owners and prospective participants, are understandable. It is only the typical lack of sophistication of the option awardee which is responsible for the issue not being more often a bone of contention.

The process of developing stock option plans which are fair and effective in regard to troubled companies is one which deserves more study than is generally accorded.

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Reader comments and suggestions as to specific examples are welcome. All submissions will become the property of British Far East Holdings Ltd. with our appreciation, but without compensation to the party making the submission.

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