Formal insolvency procedures
The success of your negotiations with creditors will determine whether you can file for consensual or non-consensual restructuring. If your creditors have the opportunity to opt out, they will usually give their consent for consensual procedures. Otherwise, they will require you to initiate one of the formal non-consensual processes.
Cases of consensual restructurings will often be conducted based on insolvency principles.
When opting for negotiations with creditors or insolvency procedures, you should be aware of your duties as director.
Insolvency procedures often affect the restructuring process since they form the ‘plan B’ if negotiations between a debtor business and its creditors fail.
• Insolvency procedures are often the last option that businesses will opt for, which may mean that in some cases it is too late to save the business.
• Insolvency processes (situations in which the business is unable to pay its debts when they are due for payment or has insufficient assets to cover its debts) are in most cases, in practice, court processes. Such court processes are a useful tool enabling initiatives from financial restructuring to be implemented in situations where commercial agreement cannot be reached between all the stakeholders.
When initiating a restructuring process, consider which formal reorganisation processes would be available in the event that a consensual agreement cannot be reached with all of your creditors.
When business is insolvent, i.e., when the business is unable to meet its debts as they fall due (cash flow insolvency) and in some jurisdictions where total liabilities exceed total assets (balance sheet insolvency), usually there are two main options or directions that it can take:
— formal reorganisation, usually initiated by the business, where there is a chance of restoring the business to viability
— formal liquidation, initiated by the business or by creditors, where there is no prospect of business rescue.
• Formal reorganisation can lead to successful exit with majority creditor consent and court approval or formal liquidation if the business does not get majority consent or court approval.
In addition, some jurisdictions may have consensual liquidation routes.
Court procedures – formal reorganisation
Formal reorganisation is a formal procedure, often supervised by a court, aimed at achieving the rescue of the debtor’s business through the approval of a restructuring plan that is binding on creditors. An insolvency practitioner is usually appointed to reorganise an insolvent or near insolvent business directly, or the debtor remains in possession and the procedure is supervised by the practitioner. Although the existing claims of creditors or security holders are likely to be reduced or replaced with different claims, it is expected that the business will be able to continue operating.
In most cases, all stakeholders, including creditors and owners, will vote on the plan. The next step is to obtain court’s confirmation of the restructuring or reorganisation plan so that it becomes effective.
If unsuccessful, this may be the gateway for a subsequent liquidation.
Some advantages are:
• interested parties (such as creditors or customers) are prohibited from taking enforcement actions to enforce the security or debt claim for a specified period without the court’s permission (known as a ‘moratorium’)
• the ability to develop a plan that provides the necessary liquidity for operation
• tax-related benefits (if applicable)
• fresh-start accounting allows for cleaning up of books and records
• sometimes protection of essential contracts to keep the business operating.
Some disadvantages are:
• the owner could potentially lose control of the business during the process
• the process can take a long time from filing to completion
• the expense can be burdensome (legal counsel, financial advisor, interested party representatives and so on)
• customers may be hesitant to continue doing business with a company that is undergoing an insolvency procedure
• the reputation of the company and the owner may be at risk as the negative association with a corporate insolvency may be long-lasting.
Court procedures – formal liquidation
A formal liquidation is court-supervised procedure that occurs when the restructuring has failed or it is not possible, aimed at selling and disposing the assets of the debtor and distributing the proceedings of such sales and dispositions to the creditors. However, liquidating the assets may be less beneficial to creditors than a successful restructuring, especially for unsecured creditors such as trade creditors since they are paid after any preferential creditors such as tax authorities and any secured creditors.
Some advantages are:
• it is a court-supervised mechanism to exit the business
• the court can assist in a free and clear sale of assets and possibly sale of the business.
Some disadvantages are:
• loss of employment and possibly the end of the business
• it can take a long time to complete
• expenses can be burdensome and there may not be anything left for shareholders and unsecured creditors
• often trustees or practitioners are charged with the sale of secured assets and there may be value erosions for secured creditors.
In many jurisdictions, there are personal insolvency procedures where the individual is in financial difficulty and faces insolvency. These are relevant for individuals, sole traders and partnerships (where there is no limited liability protection) unable to meet debts as they fall due.
Depending on the jurisdiction, a personal bankruptcy procedure may apply to a person who is unable to pay his or her debts. This may release you from certain debts and help you to achieve a fresh start.
• Often the situation cannot be resolved without the appointment of an insolvency practitioner. The appointed official helps resolve your debt problems and manage your bankruptcy.
• The insolvency practitioner will go into details of your business (including revenues and assets) and your debt, and will handle communication with your creditors.
• The practitioner may be able to realise your assets for the benefit of the creditors, such as properties, vehicles, equipment, and may need to be notified about any assets you have or receive during bankruptcy. The omission of disclosing those usually results in penalties.
Declaring bankruptcy often has serious consequences and may impact your ability to apply for funding, to travel overseas or to manage a business.
Exiting the business
Whether you are looking for a way to repay your debts or to pass your responsibilities and business to someone else, you should define your exit strategy.
Exiting the business as a last resort option – Orderly wind down of a business
An orderly wind down of a business can allow the business to sell its assets at the highest possible recoveries in order to repay its debts in full. This can be part of an exit strategy for the business provided it remains solvent.
Some advantages are
• avoiding bankruptcy
• management staying in control of business assets and processes
• creditor recovery may be potentially maximised (timely reaction when recovery is still possible)
• reputational risk potentially minimised through full repayment of all liabilities – improved ability of the business to re-enter and operate in its markets in future.
At the same time, potential disadvantages are:
• the potential for significant costs to the business to make sure all creditors are paid in full
• the need for capital investment to exit the business while winding down assets
• a potentially lengthy process (in some cases a couple of years)
• the need for a fair degree of focus to help ensure it is done properly.
Exiting the business voluntary
After many years of being in business, many owners look to reap the rewards of their efforts over the years and may want to exit the business, even where it is performing well.
Questions to consider include:
— What will happen to the business when I decide to move on?
— Should the business be sold?
— Will my children want to carry on with the business, and, if so, is there a successor ready to assume the leadership – and how will this be funded?
— Would the current management team be interested in buying the business?
— Should the business become a publicly listed company?
— How do I ensure the maximum return is received from the business?
Sometimes exit strategies or exit planning rather than succession planning is needed as there is no next generation of family members who are ready, willing or able to continue the business. In this case, you may need to consider employing non-family-members as managers or selling the business to external parties. You may be anxious about the sales process or even question if it is the right thing to do.
Questions you might be asking:
• Would it be better to sell the business than to adopt a succession strategy?
• If yes, what are my options: do I pursue a trade sale, sell to existing employees, find a suitable private equity backer..?
• What is my business worth, and how do I get it ready for sale?
• How long could it take to undergo a sale... and what is the process?
• If I sell what are the implications for me around the proceeds of the sale, how I distribute them, and my tax situation?
• How can I ensure that the business survives after a sale?
• How do I protect the family’s interests going forward?
A common response from many people in business today is that they always have an eye on the market for the right offer for their business. There are many things to consider, but also some clear objectives that you can put in place so that you are comfortable with the reasons for the sale and the return from it. Your objectives could include:
• maximising the total value received for your business
• maximising the cash received on closing of a transaction
• receiving support (financial or other) for strategic growth initiatives
• achieving financial security and minimisation of investment risk
• securing long-term employment
• pursuing a new venture or a hobby
• retiring early (or late)
• preserving the well-being of existing employees, customers and suppliers.
Selling the business
For many, the sale of a private business is the culmination of a lifetime’s work. Often, this will be a once-in-a-lifetime transaction – with just one opportunity to get it right. Sale process steps include:
— identifying and prioritising potential buyers
— initiating confidential contact with prospective buyers to ascertain their interest
— developing pricing
— reviewing the proposed transaction and the potential return
— drafting the required documents
— reviewing offers
— managing your tax position
— closing the deal.
External market considerations can, to an extent, dictate the timing of your decision. For example, an active deals market or consolidation in your sector. But there are also internal forces that are equally important when it comes to planning, which are more under your direct control. Learn where to start on the sale process.
Make sure you extract value from your property, assets, liabilities and legal and tax considerations.
You will need to consider the following when extracting value from these aspects of your business:
— landlord communications and negotiations
— valuation and sale
— environmental issues.
— optimising receivables and inventory realisations
— asset packaging and disposals
— leasing arrangements.
— assessment, negotiations and settlement of liabilities
— mitigating forward inventory orders.
• Legal and tax considerations
— contract termination provisions
— protection of tax assets
— helping to optimise tax burden.
Fully preparing the business for your exit is not a small task – it is a stressful and risky undertaking, with tax implications as well – and many business owners benefit from professional (external) advisors for these purposes.