The Parent Company (“TPC”) had existed six to seven years under the control of a venture capital group. Although it was publicly traded, two-thirds of it were owned by the VCs and its operating manager. It made, under an overseas license, a product that was distributed throughout the United States. It had an annual sales of $3 million to $4 million, and substantially all its assets were secured under a loan agreement to Union Trust (“The Bank”). The company had a negative net worth and had not made a profit the last five years. 

TPC determined it needed to expand by acquisition and went into a different industry to accomplish that. It found a chain of retail stores and while it was performing due diligence on The Retail Company (“TRC”), it opened discussions with the TRC's major supplier, The Distribution Company (“TDC”). TDC distributed products, all of which were manufactured by others, throughout the United States to 300 customers. It had two warehouses: one on the East Coast and one on the West Coast. The products were sold to retailers that did much of their business during the Christmas season. 

TDC was the largest in its industry and was privately held with sales of approximately $25 million and an irregular earnings history (Exhibit A, TDC's audited financial statements, and Exhibit B, the bank's analysis of the financial statements). 

Preparation Questions

1. Outline the transactions. Include the flow of funds among the individuals and corporations. 

2. What specific risks was the bank trying to protect itself against? Which specific terms were intended to provide the protection? 

3. What do “subordination” and “personal guarantee” mean to the respective parties? 

4. What in the numbers indicates why the bank took the position it did?