Transaction Type: As part of the purchase, a company that manufactures and distributes bicycle helmets, bicycle accessories, bicycle racks, and other related equipment refinanced its working capital line of credit. The proposed line of credit was $185MM with a $75MM revolving line of credit and two term loans for the remainder amount.

Significant Finding: During the initial exam, the company had been moving its books and records to new headquarters in another state, so some of the credit memo and other dilution testing could not be completed. Based on robust sales data and forecasts that showed that the company would have adequate cash flows to satisfy the debt structure being proposed, these open issues were eventually waived. Approximately 60 days after the acquisition of the company and subsequent funding of the credit facility, the company began to demonstrate large past-due receivables.When noted by the lender, the company went about “reconciling” these past-due amounts. Suddenly the current column of Accounts Receivable Aged Trial Balance ballooned. We were asked to perform an update of the initial examination performed. We found that the company had held credit memos and not processed open debit memos related to various discounts and allowances for about a quarter. In addition, it became apparent that the company had gone on a campaign to increase sales to attract a buyer. These sales, often termed “stuffing the channel,” were made attractive to customers through heavy discounts, allowances, and the possibility of return. In reconciling sales, we found several layers of hidden credit memos, discounts, and allowances that resulted in a quadrupling of the company dilution reserve.

Impact on Transaction: The increase in reserves put the company into an over-advance position. The bank group put the facility into default. A new set of managers was brought in, and the bank group agreed to forbear for six months to give the new managers a chance to turn the company around. During our initial examination, we pointed out several other areas in inventory and receivables that, if managed properly, would result in improved working capital and asset performance.