Recent statistics are quite startling, with less than 8% of companies in Business Rescue successfully recuperating from financial distress. This suggests that the majority of companies entering Business Rescue did not have realistic and deliverable long-term business plans and could not produce the cash flows that were initially projected when Business Rescue was applied for.
A contributor to this is the general assumption that Business Rescue constitutes a predominantly legal process. In reality, the essence of a successful turnaround ultimately depends on the company’s ability to generate cash, thereby enabling it to exit Business Rescue and become a self-sustaining business.
The importance of seeking legal advice when considering filing for Business Rescue is irrefutable. However, according to Stuart Wilson, Associate Director in the Restructuring Team at Deloitte, there appears to be insufficient focus given to challenging the business plan which underpins the entire decision-making process. This is especially relevant given that the plan has generally been prepared by the directors and employees of the company, all of whom have a vested interest and an emotional attachment to assuming that the business can be saved.
The purpose of Business Rescue
Business Rescue, as defined in Chapter 6 of the Companies Act 71 of 2008 (“The Act”), is a substantively non-judicial, commercial process which seeks the ultimate rescue of a company in financial distress by maximising the likelihood of the company’s existence on a solvent basis. Failing this, Business Rescue seeks a better return for creditors and/or shareholders than would result from the immediate liquidation of the company.
Is Business Rescue working?
In 2012, the number of voluntary liquidations decreased by 24.5% relative to 2011, while the number of compulsory liquidations decreased by 16.8% in the same period. This gives some credence to the interpretation that companies are benefiting from Chapter 6 of The Act, which came into effect in May 2011. However, at present, only approximately 50 out of the 700 companies that have filed for Business Rescue have successfully turned around – surely a statistic which must be improved?
Could the reason for failure be the legal emphasis on Business Rescue?
Although Business Rescue is functionally non-judicial in nature, the current trend in South Africa places the decision of whether to file for Rescue (and the determination of the likelihood of success) in the hands of the Board of Directors and a trusted team of lawyers. Key decisions in this process are based on the business plan prepared by the Board of Directors and employees, often overlooking their inherent emotionally charged bias stemming from their desire to see the business succeed.
This typically results in over-optimistic operational and financial projections which overstate the forecast cash flows and understate the funding requirements of the business. In light of this, one has to question whether Business Rescue in South Africa is too legally focused, and whether key financial considerations are overlooked in favour of legal considerations.
A sure-fire solution: Increased financial analysis prior to filing
There is a far greater role for independent financial specialists to play in providing an objective and realistic view on the business plan, prior to filing for Business Rescue. This independent viewpoint will enable both the lawyers and the Board of Directors to take a clear view on the integrity of the business plan and whether Business Rescue is a viable option. A good financial advisor will also highlight other potential mitigating actions that could be pursued (e.g. sale of a division / asset, cost restructuring exercises) that may not previously have been considered, and could even avoid the need for Business Rescue entirely.
Seeking this sort of advice can only improve the success rate of Business Rescue in South Africa by excluding those companies which have followed the process as a last ditch attempt to rescue an ultimately doomed company.
It is becoming increasingly evident that if you don’t adequately prepare for financial distress and Business Rescue, chances are you probably won’t survive it.
All directors must consider the question, “Have you hedged your bets by seeking the appropriate legal and financial advice for your company in sufficient time to make a balanced decision on your options?”