Considerations for companies in distress

‘Massive increase’ in the number of crisis business sales seen as inevitable.
Companies will benefit from a combination of bridging finance and legal and business expertise to help identify cost-saving opportunities or new revenue streams. Image: Shutterstock

As calls for an easing of the draconian lockdown restrictions imposed by government go unheeded, more and more companies are losing the battle and will end up in business rescue or liquidation in the near future.

Even before the lockdown, imposed in response to the global spread of the coronavirus, a number of businesses had already shut down.

“We are going to see a massive increase in the number distress sales of businesses soon,” says Joshua Janks, partner at law firm Bowmans. “It is inevitable.”

Businesses will instinctively try to survive by cutting costs in any way imaginable.

“However, you have to weigh that up against the long-term sustainability of the assets or business,” says Janks, adding that if such cuts are not sustainable it may be preferable to rather focus on retaining as much value in the business as possible.

Read:

This will ensure a better return if there has to be a distress sale.

Stefan Steyn, senior business rescue practitioner at Business Rescue Partner, says the two key considerations in determining the ‘state of the business’ are its cash burn rate and operating leverage.

Cash burn rate

The cash burn rate must be slower than the cash conversion rate. If you have 20 days of cash left in a cycle but your cash conversion rate is 28 days, there is a problem.

“If the difference in days is increasing month to month and you do not have increased payment terms with creditors then the demise will be even faster,” says Steyn.

Operating leverage

Operating leverage is gross profit less costs (labour and property) divided by turnover. In most industries, there is cause for concern if this amount is less than 10%. And if the ratio is below the industry benchmark for three consecutive months, then there are problems for that business.

“Most companies do not do these calculations because their financial statements are often not up to date or the information in the financials or management accounts is [viewed] in isolation and not used to monitor trends on an ongoing basis,” says Steyn.

Protect the cash

Although it sounds impossible at times like this, companies are advised not to run out of cash and then become desperate, says Tim Stokes, attorney and business rescue practitioner.

“There are sharks out there that will pick up businesses for next to nothing because the [owners] are in a desperate situation and have left themselves with few options.”

When considering whether to fund companies in distress, FyreFem Fund Managers will be looking at the results reported for the six months to December last year, says CEO Cathy Goddard-Edwards.

If a company was in distress before the arrival of Covid-19 the chances of obtaining funding will be slim.

Companies need to carve out time to get on top of the things that are too high in administration and too process-orientated for a prospective funder to handle, she says.

“Ensure that all the minutes of meetings are up to date, that all material legal agreements are on file such as insurance policies, lease agreements, and any guarantees or sureties the company has signed; have a complete list of assets and any employee related provisions.”

The Southern African Venture Capital and Private Equity Association (Savca) has launched an initiative asking members with excess capacity to volunteer their skills and expertise to help businesses that are in distress or facing an immediate crisis.

The value of a ‘fresh pair of eyes’

Savca CEO Tanya van Lill says companies need a combination of bridging finance and legal and business expertise to offer a fresh pair of eyes in terms of cost-saving opportunities or new revenue streams.

She says their members are focusing their attention on companies in which they are already invested and making sure they can weather the storm.

The reality is that businesses need to ensure that as much output as possible is deferred rather than destroyed.

However, the initial move to what is now described as Level 5 lockdown restrictions on March 26 gave very few companies the opportunity to do so.

The ‘informal’ business rescue option

Eric Levenstein, head of the business rescue and insolvency practice at Werksmans, says that when creditors begin to get aggressive and when threats of applications for liquidations become an issue, it is time to consider business rescue.

The company can engage with some or all of its creditors informally – outside of a formal business rescue process – with regards to restructuring the company.

The company will not have the benefit of a moratorium that will prevent creditors from enforcing their claims, but this will create an opportunity to negotiate and agree on a ‘prepackaged’ sale of a distressed company.

“A prepack will only work in circumstances where the company has a small group of creditors who are prepared to work with the company prior to the commencement of any formal business rescue proceedings.”

In this way, says Levenstein, a commercial transaction can be finalised without the cost of a formal business rescue process, which can be expensive.

Janks says that if the sale of the business becomes inevitable, the need to move fast becomes crucial. “It is a difficult decision and very emotional – but is it a critical point.”

The more desperate the situation becomes, he says, the greater the potential for value in the business to be destroyed due to poor decisions.

Listen to Nompu Siziba’s interview with Banking Association of South AfricaMD Bongiwe Kunene:

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Why would you take out a loan if you have no idea when and under what further draconian regulations your business can be opened?

How do you know you can ever pay back the loan.

Maybe its better to just go bust. The whole “Business Rescue” process will bankrupt your business anyway. Its one big scam.

Business Rescue does not Bankrupt your business. A Practitioner that is accredited by a Professional body is one that is required to act by law in an independent and honest manner. A Reasonable Prospect analysis needs to be concluded of each business. Liquidation has a massive social impact and if it can be saved it should!

@TRS: I seem to disagree with your assumption that Business Rescue does not bankrupt a business. If your company is moved into a BR environment then the business is already technically insolvent.
There is no particular purpose of this process other than to either asset strip or squeeze the last of the juice from the cash lemon. The ratio of BR vs successful saving of companies is somewhat dismal as of the 8 companies I know that went into a BR program – NOT ONE has survived. And one of them was an R800m turnover labour brokering business. As noted in this thread just look at Nova/Sharemax BRP ethics, SAA and a host of other instances. Just another added layer of administrative unwarranted costs.

I think the SAA debacle is a good illustration of what BRP’s actually do; kow tow to the powerful and pocket their fees.

You have to wonder about how some people think. While getting quotes for projects we need to get going, it was clear there are two types:

The ones that give incentives and slash lead times in order to get some business going.
The ones that want to charge a premium now to make up for lost income in April.

Given the bungling with UIF payments, the refusal to help businesses owned by those of the wrong hue, and the irrational nature of the regulations, such as preventing e-commerce, any recovery after the suicidal lock-down is going to see a very changed business landscape. Many small businesses are going to choose to go underground, away from the receiver of revenue or the prying eyes of the state.

This is a perfectly logical thing to do. Nobody is going to pay insurance premiums on his car, if he knows that his insurer won’t pay out if he’s of the wrong skin colour, or because the insurer is so incompetent that only 30% of claims get paid. I expect to see a huge underground, black-market economy developing, with the previous revenue that the state received, simply disappearing. Bitcoin and cash payments, after all, don’t exist in the SARS world.

@Incitatus
You are 100 % correct that there will be smaller companies that will stop being the milking cow of parasitical, corrupt and dysfunctional government institutions. That is if they survive the present economic conditions at all. A rethink in this regard is in any case on the card.

@Turnaround Rescue Solutions – well put.

Unfortunately the general public and also those whose hold a crayon here, is ill-informed and have their opinion formed and enhance their knowledge by reading headlines.

If you use SAA as an example of a BR, its the worst example ever as reasonable prospect is politically driven.

In general and for those who know (i.e., those who do not get carried away by headlines like a mob of sheep), BR does work.

I see words like ‘scam’, ‘will bankrupt you business’, etc. Good candidates for the upcoming elections to take seats as MP’s. That should match your IQ if your age doesn’t.

As calls for an easing of the draconian lockdown restrictions imposed by government go unheeded….

You have got to ask 3 questions.

1 why are these calls going unheeded? And
2 what has the lockdown accomplished? Where would the death rate be if we had had zero lockdown with just wearing of masks, etc instead?

And the big one I guess. What is government’s motive in keeping the lockdown running given the enormous damage it’s doing?

One last curiosity…what is the rand doing at only 18,50 odd?

End of comments.

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