Reorganization value: What it is and isn’t
Reorganization value is important because it is perhaps the measure that determines whether a debtor is able to reorganize, and the value of the reorganized debtor that is distributable to holders of interests and claims. However, reorganization value is not specifically defined in the Internal Revenue Code or in case law, other than by reference to the general principle that a debtor should be valued based on the capitalization of its future earnings.
Courts determine reorganization value by reference to the debtor’s enterprise value, based on the fair value standard; going concern premise and present value; expected future cash flows or market multiples. However, reorganization value is not the same as enterprise value, although the terms are frequently confused with each other and used interchangeably. Enterprise value is a component of reorganization value, although its value may be less due to the value of items such as current operating liabilities, excess cash and other non-operating assets.
Each component of value must be understood (such as cash flows included in a calculation and how they differ), in order to intelligently analyze an investment or negotiate to maintain or enhance an interest or claim in a restructuring.
Generally, there are two types of free cash flows: free cash flow to the firm (FCFF) and free cash flow to equity (FCFE), with the FCFF model best suited to measure firm value, enterprise value or reorganization value. Where the cash flows used to calculate reorganization value are attributable to the operating assets of the reconstituted debtor, the measure of value will be enterprise value. Reorganization value can then be found by adding the value of excess assets, other non-operating assets and current operating liabilities.
Read a recent article published in the AIRA Journal from RSM US LLP’s Boris Steffen to understand how to determine the value of a firm, including insights into enterprise value, reorganization value and comparing FCFF and FCFE.