How do I save my business that is experiencing financial distress?

By Andrew Rumsey (Client Director at Portland)

This article sets out to provide clarity on how insolvency practitioners and insolvency processes can be used to help rescue a business. Obviously, an insolvency process is not always required to save a business. However, where the circumstances are such that the company is unlikely to survive without this intervention, it is important to understand the benefits of each process and when they are applicable.

First, before considering an insolvency process, let’s review some of the underlying issues facing businesses and what alternative solutions can be used.

insolvency rescue

Cashflow

Sometimes a business can be profitable and yet, it does not have sufficient funds available to pay its creditors when required (cashflow insolvency). In these circumstances, a financing option such as invoice discounting may enable a more reliable cashflow for the business. Alternatively, improved debt collection processes may assist, including the use of external debt collectors.

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Historic debt

In the initial stages of setting up or during a period of poor trading a business may be loss making.  This can make it difficult to pay all creditors when required, even though the business may have since returned to trading profitably. Again, re-financing can be an option in these circumstances to enable payment of the historic debt over a longer period. However, it is important to ensure that the loan is affordable for the duration of its repayment period.

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Reducing turnover or profit margins

Sometimes changes in circumstances or a difficult trading environment mean that a business sees a reduction in its turnover and/or profit margins.

In these circumstances a review of the following may help identify areas to remedy:

  • overheads and direct costs – required to establish whether savings can be achieved;
  • products or services to consider whether pricing should be changed; and
  • a review of the current sales and marketing plans

It may be appropriate to contact your accountant, a business consultant or other trusted adviser to assist in this process. However, even though some of the above may assist, sometimes the circumstances are too severe to survive without the use of an insolvency process.

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INSOLVENCY OPTIONS

Fundamentally, there are three options when it comes to saving a business through insolvency:

  • company voluntary arrangement
  • administration
  • liquidation

Each process has its own merits, depending on the circumstances of the business.

Company voluntary arrangement (‘CVA’)

A CVA allows a company to continue trading, having reached a compromise with its creditors about its historic debt and, potentially, future costs. Ordinarily, the company will make a monthly payment (‘contribution’) into the CVA based upon its forecast profits. This process usually lasts for up to 5 years and results in creditors receiving an agreed percentage of what they were owed by way of dividends over the period of the CVA.

A CVA is only appropriate in certain circumstances, as it requires the company to be able to demonstrate it can provide a worthwhile return to creditors, usually by making sufficient profits in the future to pay the agreed contributions. This may arise for a number of reasons:

  1. It suffered a significant catastrophic event, eg
    a) a bad debt from a significant customer
    b) a disruption to its otherwise profitable trading (ie temporary closure/damage to premises).
  2. It has suffered a reduction in turnover or profit margin but has or can achieve a restructuring of the business (ie reducing costs/increasing prices/disposal or closure of loss-making division)

If a company can demonstrate that, but for one of the above reasons, the company was and will be profitable again, then a CVA can be an excellent tool to ensure its long term success. However,  without this a CVA may not be the right answer. As such, it is worth considering the alternatives.

Administration

Insolvency law sets out the purpose of administration:

  • To rescue the company as a going concern;
  • Achieve a better result for creditors than if the company went into liquidation; or
  • Enable a distribution to either secured or preferential creditors

Liquidation is usually associated with the closure of a business and administration with achieving a sale of the trading business. Whilst this is not a necessity in either process, administration has certain advantages to assist in selling a business as a going concern:

  1. Protection from creditors – Where there is a secured creditor (usually a bank or other finance company providing lending) the company can use the protection of a moratorium in the period leading up to the appointment of Administrator to protect the company from its creditors. This can assist it continuing to trade, where it may otherwise be at risk of other civil procedures, pending a restructure or sale. With the exception of the secured creditor, there is no requirement to notify other parties of the process at this time, which makes it easier to carry on trading whilst the relevant plan is put in place.
  2. Following appointment, the company continues to have protection from creditors and the administrators can continue to trade the business whilst the marketing and sale of the business is ongoing. Administrators are granted certain powers to assist in this process. At this stage creditors must be notified as soon as is reasonably practical.

Administrators should be able to demonstrate that the best outcome for creditors was achieved and ensure the sale of business is appropriately marketed. This of course means that a company’s directors can purchase a business back from Administrators, although there are certain additional reporting measures (see SIP 16) required of the Administrators when this occurs. Sometimes the sale of the business may occur on the day of appointment follow a pre-appointment marketing exercise, this is commonly known as a prepack.

Whilst the company will eventually be dissolved, the underlying business is often saved and moved into a new company, or merged with another company. It also generally ensures a smooth transition of the business, thus maintaining the goodwill of the business and saving employees jobs.

Liquidation

For the purposes of saving a business, a liquidation process can be used where, despite a potential sale of the business, it is unlikely to achieve one of the purposes of administration.

In this circumstance, the company must notify its creditors of the proposed appointment of Liquidators and send a pack of financial and other information explaining the company’s position.

It is often the case that a company will cease to trade in the week’s leading up to the appointment of Liquidators because it is insolvent and cannot continue without worsening the position for creditors. However, were it is beneficial to do so, the company can continue to trade up to the date of liquidation. This may be for:

the purpose of completing profitable contracts; or

maintaining the goodwill of the business prior to any sale.

However, trading should not continue to the detriment of creditors, ie where further credit is incurred or the continued trading does not add value in some way. In addition, once suppliers have been notified of the proposed liquidation it may prove difficult to continue trading. As such, it is important to have planned thoroughly and considered the pro and cons of continued trading.

Even if a company needs to cease trading before the appointment of Liquidators, there is nothing stopping directors of the company purchasing the assets from the Liquidators. However, similar to the requirements of Administrators, when selling assets to an associated party the Liquidators must abide by the best practice guidelines (see SIP 13) when conducting the sale and reporting it to creditors.

The content of this article was correct at time of publication.

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Need further support and advice?

Contact us today and our experienced can advise on all the different aspects of liquidation to ensure the most positive outcome for you and your business.

Call 01489 550 440 or complete the form for free advice or a no-obligation consultation

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