#50 Joseph E. Sarachek - Distressed Investing

The Nalu Finance Podcast

In this episode of Nalu Finance, we sit down with Joseph E. Saracheck, Partner of the Sarachek Law Firm and Managing Partner of the Strategic Liquidity Fund, to explore how the distressed investing market works and what will drive its next wave of opportunities.

From debunking the "vulture investor" myth to explaining his playbook for buying troubled assets, Joe offers a hands-on perspective on finding value where others see only crisis. As one of the few people who has seen the distressed world from every angle, he shares how combining courtroom strategy with Wall Street deal-making uncovers hidden value.

What’s Inside:

• What counts as a "distressed" asset and why investing in troubled companies isn't just "vulture" bottom-feeding.

• When a company you invested in goes bankrupt: what to do next, the red flags to watch, and why knowing your place in the capital structure will determine your recovery prospects.

• The next wave: why a looming private credit "train wreck" could unleash a surge of new distressed opportunities and where to spot early warning signs of trouble.

Why Listen:

 This episode is a masterclass in distressed investing, delivered by a practitioner who's seen it all, from the courtroom to the classroom. Joe distills decades of legal and financial experience into actionable insights that demystify this complex corner of finance. Even with so much ground covered, it's clear one conversation can't capture all of Joe's knowledge (he literally wrote the playbook on this). Special thanks to Joe for providing our listeners with a 50% discount on The Distressed Investing Playbook so you can continue learning beyond the podcast. Click here to get your discount code.

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🎙️ Transcript: Intro: 00:01 Nalu FM Finance Podcast. Insight into the financial markets.

Joe Sarachek: 00:10 The problem with today's market is everybody has money, a lot of money, and there's pressure to pay up. So you need to have true conviction.

Sponsor: 00:22 This podcast is powered by Vestr, the engine behind Active Management. Vestr is a Switzerland-based fintech startup that provides software for issuers of actively managed certificates to automate their value chain fully. Visit Vestr, V-E-S-T-R dot com to schedule a meeting with an expert and to learn more about Vestr.

Stefan Wagner: 00:44 I'm very excited. I got a new guest, Joe Sarachek. Thank you, Joe, for taking the time. You are a lawyer, an investor, but you also like to give something back, teaching at NYU Stern School. But your passion basically is distressed investing. You have spent decades on both the legal and investment side in this job. For listeners who may not be that familiar with stress investing, what kind of situations or assets fall under this category? And why might someone deliberately invest in a company that is in serious trouble?

Joe Sarachek: 01:20 Sure. So it's not just companies. So I categorize it into four segments. And they are what I call trade claims or accounts receivable. real estate notes or mortgages, special situations like investing in a litigation, and operating businesses, like operating businesses or buying a business that's in trouble and turning it around. Unlike investing in healthy companies, the investment in a distressed asset has an element of turnaround and therefore there'll be a bump or an increase in the return on the investment if done properly.

Stefan Wagner: 02:10 Okay. Now, some people might think it's sort of… Distressed investment is taking advantage of somebody. It's sort of a vulture stigma. Gets a bad rap, you know, you're picking up, you know, awful pennies on the dollar. How do you describe the value or opportunity of distressed assets to someone who is skeptical? You know, why can it be a positive and obviously profitable strategy to do that?

Joe Sarachek: 02:39 Yeah, there are the terms vulture investor, bottom feeder, grave dancer, but that's, that's really not what it is. Great things can come when someone is investing in distressed assets, such as creating or saving jobs. And like one of me. Favorite cases of all time was a bankruptcy in Iowa where thousands of family were dependent on a business that when I came in was shut down I was brought in as uh the trustee the bankruptcy trustee we restarted the business And the business employs several thousand people, but regionally it probably employs tens of thousands of people. So that's like a turnaround and that's a feel good story. And I didn't buy into that business. Like as an investor, I was hired as a, uh, as an advisor, but had I bought into the business and let's say bought into it for cents on the dollar for deep discounts and saved and created thousands of jobs, you wouldn't call me a vulture, would you?

Stefan Wagner: 04:00 No. No, I wouldn't. Now, in these cases, it was planned to go into such an investment. But I assume many investors sometimes end up unintendedly in bond or stock and a company goes bankrupt. What can they do when they end up in such a situation? What should they do?

Joe Sarachek: 04:24 So this is why there is a market in distressed assets. Some investors should just sell. They should get as much cash as they possibly can and put that cash to work in something else. That's the right thing to do. Other investors who have a vision, who have patients and, and maybe even more capital to deploy, then they should consider being buyers. Obviously it's a case by case situation. There are some situations that are just so rough and so bad and that you're better off cutting your losses.

Stefan Wagner: 05:08 Now, what are the things that you can look out for to avoid actually getting to that situation? What are the red flags, the warning signs?

Joe Sarachek: 05:15 Sure. The first sign is a high debt load and the inability to service that debt. There are just some companies that have so much debt You know if a business is faced by unexpected things like the pandemic or tariffs that's a different story now.

Stefan Wagner: 05:40 Also often I find people don't understand actually where they sit in the capital structure you know equity subordinated dad you know preferential equity what other. Can you explain why it's important for them and how an investor recovery prospects depend on their position in the capital structure?

Joe Sarachek: 05:58 Sure. Whether a company is in bankruptcy or not, all investors use the same rules of priority in getting paid. For instance, the senior secured lender or creditor is paid first and typically has a lower return profile, like an interest rate. The trade creditor or unsecured creditor is paid after the secured creditor. And of course, lastly, is the equity holder, and that's the most risk and should also be the greatest return.

Stefan Wagner: 06:36 Is there anything in there also in these rules when you get paid?

Joe Sarachek: 06:40 So the answer is in the U S bankruptcy code, there's a, a process after filing bankruptcy that allows a company a certain amount of time to follow a plan of reorganization. The company also has to follow a document called the disclosure statement. And that disclosure statement spells out the form of consideration you're going to get. And also. when you're going to get paid.

Stefan Wagner: 07:19 evaluate a troubled company, how do you determine whether its asset can cover its liabilities? Do you look at the liquidation value of hard assets, ongoing cash flows, brand? I mean, goodwill, I don't know how much that is worth when you're in trouble, but to determine a realistic recovery rate, because you said it right at the beginning, you need to know how much could you lose, and, you know, that's probably determined by your recovery rate.

Joe Sarachek: 07:47 So it really depends on the size of the company and the type of asset. And I have six rules in my book I talk about, but one of them is determine the liquidation value. And it really starts there. It's never good to value a company based on some value that the company thinks it's worth, because let's face it, companies in distress, they're idealistic. The value that they're going to give you is always greater than it is. With retail businesses, there's really only a couple of assets, the inventory and maybe the real estate. And there are ranges that inventory typically liquidates out at real estate is pretty efficient. And of course it depends whether the asset is owned or leased. Um, but usually in large distress situations, the market has told you, even before the company gets in trouble, what the assets are worth. And you can just look at what the debt is trading at. So the market is typically, in large situations, efficient.

Stefan Wagner: 09:07 Often how these companies get in trouble is often by not managing their cash flow. We often see businesses that are asset rich, but cash poor and end up in distress. So how important is liquidity, day-to-day cash flow in this case, and preventing or driving a bankruptcy?

Joe Sarachek: 09:23 I mean, it's a universal principle in all businesses everywhere, which is If you run at a deficit at a loss, if you're not making money day in, day out, you're increasing the riskiness of the business. Simply put, you want to generate positive cashflow in all businesses that you start as quickly as possible. You know, otherwise the power, the control shifts one to the financing source and two to the creditors.

Stefan Wagner: 10:00 Which is a little bit my next question when you go into these distressed situations. This involves numerous players with competing interests. Senior lenders, junior creditors, management, shareholders, employees, unions, pension funds, regulators, courts. How do these stakeholder dynamics influence the outcome of restructuring or bankruptcy? If all small guys get together, can they actually shift the power dynamic in this versus a large person who bought maybe up 20% of the debt?

Joe Sarachek: 10:32 I represent often as a lawyer when I'm not with my investing hat on. I represent vendors and creditors and little guys. And yes, I do pull them together. But the reality is he who has the gold rules. So the senior creditor, um, he rules, he controls, he calls the shots. Now we do our best and we have all sorts of very clever techniques to level the playing field. Um, at the end of the day, what's this all about? This is all about, there's a limited amount of money. And we want, on behalf of our vendor clients, as much as possible.

Stefan Wagner: 11:19 Okay. We always say, you know, buy low, sell high, in a sense. It's come from the trading side. But I think the same thing applies here, isn't it? Investing that you make money by buying it, hopefully cheaper than what you can realize or sell. And, you know, how do you evaluate the price you pay for a disruptor or equity position relative really to its likely recovery value? In other words, what's your process for determining if an investment is cheap? quotation mark enough to be attractive giving the risk i mean i remember FDX you know people. The claims of trading very cheaply and then suddenly to realize hold on they also have this huge investments and other company that's worth actually something.

Joe Sarachek: 11:58 Yes I’m the number one rule the number one rule the most important role in distressed investing is buying right. And I spent a lot of time in my book the distress investing playbook talking about. Uh, this and how can you make sure that you're buying right? And how do you do the right, um, analysis and due diligence and have the patience to do it. I've had situations where I bought, um, right. So right that I immediately, I locked in instant profits and I've had situations that are rougher where I paid too much. And the balance of my life with this investment opportunity, I'm basically trying to get back my principle and, um, and, and protect, you know, myself and my investors. The problem with today's market is everybody has money, a lot of money, and there's pressure to pay up. So, so you need to have true conviction.

Stefan Wagner: 13:11 There's two different types of strategy, trying to get the business and then actually operate it versus trading it, buying the claim and then selling it, hopefully, which is more of a passive approach. Can you compare these two approaches? What makes sense for certain investors?

Joe Sarachek: 13:30 I talk about this in my book, active versus passive. I prefer being a passive investor Uh, and much more of a trader. I love liquidations and event driven recoveries where the risk is minimized. Distressed investing should be about minimizing risk. Being an active or a control investor has so many more variables some beyond your control. I don't like being up at night worrying about are the sales coming in did all the employees show up for work is there a new tariff in town today that we didn't know about you know yesterday.

Stefan Wagner: 14:20 But obviously, you have to gauge somehow, I mean, what is the likelihood in a distressed company to actually turn around operationally? Do they just need more capital? Do they need to refinance themselves? I mean, in your experience, how important is the viability of the underlying business to the ultimate success?

Joe Sarachek: 14:40 Operational turnarounds are tough. In my experience, the success of one is part fundamentals and part luck. One of the most important things that's often overlooked is an industry expert leading that company. That's far more important than a bankruptcy professional.

Stefan Wagner: 15:06 The playbook is full of vivid world examples from your career. Could you share one of your favorite war stories?

Joe Sarachek: 15:12 Sure.

Stefan Wagner: 15:13 Maybe the company looked like a lost cause and lots of surprises.

Joe Sarachek: 15:19 So this company was called Petro Wax and there were a couple of factors. One, the fund that controlled it had a lot of dry powder. And two, we had a very experienced industry expert who had an idea about how to effectively create a new revenue stream. You want to effectively buy low or restructure low and sell high.

Stefan Wagner: 15:50 And is there anyone like on one where you had a failure base here or it didn't go the way you were hoping? What sort of were your takeaways and what did you learn from it?

Joe Sarachek: 15:59 Yes. So in every situation and you know, I'm going to write, my next book is going to be what I learned from my failed distressed investments. What I learned was I backed the wrong horse. Lesson one. The next point is. Don't spend a lot of time on small deals. Small deals rarely yield large returns. I'd say lesson two is, you know, or this might be lesson three is if you have a bad feeling about someone run, run, move on. Don't do the deal. Well, you've had that happen in life.

Stefan Wagner: 16:46 Every time, every time. I should have just listened to my guts.

Joe Sarachek: 16:51 And your gut is based on your collective experiences. The next lesson is you're always going to need more money than you think.

Stefan Wagner: 17:02 Now, if somebody wants to get started in this business, you know, if someone wants to break into the stressed investing, where do you get started if you want to do that?

Joe Sarachek: 17:10 There's no doubt a legal or accounting background is definitely a plus but the best way and this is what I say to my class. Is to get involved in something you know a business you know in industry you know you have a skill set.

Stefan Wagner: 17:29 I mean, when I was trying to learn things as well, because I originally came with a computer science background into finance, I was trying to look at the people out there that I really thought knew what they were doing and try to learn from them. Are there distressed investors or firms that you think are worthwhile to be studied or to be followed?

Joe Sarachek: 17:53 There are some great ones, Elliot, Oak tree, a great one, Anchorage, Davidson, Kempner, uh, Mark Lazury. The greatest thing about the time we live in now, you could put Google alerts out and follow people, literally follow them and get information about the deals they're doing. Listen to Bloomberg news, read the FT, read the wall street journal, um, read sub stacks, read your column, read my sub stack, the distressed investing playbook. Those are places where for free you can get information.

Stefan Wagner: 18:32 Now, looking ahead, we know what's happening here. What big picture trends do you see shaping the distressed investing landscape in the next few years? Are there factors like the rise of private credit versus private equity, change in interest rates, or new restructuring law that you think will create more or fewer distressed opportunities going forward?

Joe Sarachek: 18:54 This is a very timely question with the blow up of first brands. Private credit is a train wreck waiting to happen. Okay.

Stefan Wagner: 19:02 We're fully agreement here. Yeah.

Joe Sarachek: 19:04 These are funds that have massive, massive amounts of money and they need to put out a hundred million, 200 million, 500 million. And the reality is there's just not that many situations to do it in. It's unregulated. And distressed investors and up and coming distressed investors just need to follow the deals that are being done. And by the way, even though they're private companies and private deals. If you follow business development corporations, BDCs, which many of these private credit funds fall into, you can go online and you can, meaning in the SEC filings, and you can see what positions they are marking down quarter to quarter.

Stefan Wagner: 20:01 Ah, yeah. Good point. Finally, what should be for the listeners, in a sense, what's the one lesson they should remember if they haven't read your book?

Joe Sarachek: 20:11 Your next deal is in your backyard. You already know the subject matter of your next deal. And anyone with common sense can make money. The objective is to buy low, sell high. You just need to do your due diligence and buy it right.

Stefan Wagner: 20:33 Joe, incredibly enlightening. Thank you, thank you very much. Last two or three questions for you so a little bit people get a feeling who you are maybe a little bit. So what drives you or can you tell us something interesting about yourself that maybe not everybody knows?

Joe Sarachek: 20:48 Okay. Most interesting thing recent is every morning I get into 49 degree water Fahrenheit in a cold plunge. It's freezing cold. I end up shivering. My chest is red as anything, but I've really enjoyed this cold plunging. It wakes me up. I feel it gives me tremendous energy. That's one thing. Two, I love distressed investing. I want to bring distressed investing to the world.

Stefan Wagner: 21:24 And what is your personal definition of success?

Joe Sarachek: 21:28 Great question. The most important thing to me is my wife, Heather, and having a meaningful relationship. I feel right now I'm very successful in that area. And of course, I have five kids, my kids as well.

Stefan Wagner: 21:45 Last question. What is on the top of your current music playlist? What do you like to listen to?

Joe Sarachek: 21:50 I'm a deadhead. I love, love, love, love John Mayer. John Mayer is in Dead & Co. and I went to see him in San Francisco. This up-and-coming guy, well, he's more than up-and-coming. His name is Billy Strings. I like jam bands. And you?

Stefan Wagner: 22:16 What's your… I mean, for me, it's easy to define what I don't like. I do not like anything beyond really heavy metal. That's where I stop out. Anything above ACDC, probably. Free jazz, when it gets completely chaotic, I don't like. And also 12-tone music. You know, the classical side becomes… You know, the Russians, when they do too many… Instead of octaves, they do 12. That doesn't gel with me either. But otherwise, pretty much anything you can dance to, probably I will like. Thank you, Joe. That was extremely insightful. Thank you for taking the time.

Joe Sarachek: 22:54 Okay, you're welcome. Be well.