In recent weeks, there has been a gradual easing of movement restrictions in most states. As things settle into the ‘new normal’, the financial impact of this pandemic can begin to be fully understood.
PwC’s recent Act Now to Recover survey, which examines the disruption faced by business owners in the current economic climate, found that 29% of respondents have experienced and also expect to experience a cash shortage over the course of over the next 12 months. Therefore, if companies can be able to manage in the short term, they must ask themselves the question: what if cash reserves continue to dwindle and the goodwill and support they have received? creditors were running out?
When a business can no longer honor its debts as they fall due, it usually has two options: embark on a restructuring exercise or accept that the business is no longer viable and put the money down. company in liquidation.
A restructuring could result in a range of actions such as injection of capital or new business by current shareholders or new shareholders, reduction of lost capital, sale of non-core assets, resizing of operations and cancellation of debt by creditors to reduce debt to a level that can be supported by post-restructuring net cash flow. The board should assess all available options, balance the rights and demands of stakeholders, and make a decision on next steps. If the board decides to restructure, all relevant stakeholders must âbuy inâ to the success of the restructuring exercise.
It would follow, however, that those stakeholders with the most rights to a company’s cash flow or assets should have the most say in restructuring. In times of distress, this stakeholder group is likely to be the creditors. When there is insufficient cash flow to pay debts on existing terms, creditors would in all likelihood be asked to agree to some form of compromise as part of the restructuring exercise. A negotiation process usually precedes the consent of the creditors to the proposed compromise terms.
Compromising with creditors or debt restructuring will involve compromises on both sides and often involve creditors agreeing to less favorable terms on their debt to help ensure the long-term survival of the business. Before creditors agree to such a compromise, they will naturally want to review the business plans and forecasts. This will require meaningful communication and efforts to build trust between the two parties every step of the way.
Early engagement makes the difference
Being sensitive to the first signs of distress and proactive early engagement with creditors will give companies more options to restructure their businesses. Creditors should be more confident that their efforts to help the business will bear fruit if the business has not yet deteriorated significantly. For this to work, companies must view their creditors as business partners on their recovery journey and communicate their weaknesses openly. Likewise, creditors must also have the willingness to work alongside the struggling business owner to overcome any obstacles to long term survival.
Consider this example: A business operating in an industry hard hit by Covid-19 may face working capital issues due to reduced sales. His first instinct may be to negotiate with his commercial creditors to lengthen credit conditions. However, he could also consider asking the bank to turn the existing debt from working capital into a fixed term loan that can be supported by the expected net cash flow.
In addition, a request for new or additional working capital facilities may also be considered if there are unencumbered assets that could be accepted by the bank as collateral. This is a compromise that could be struck early if both sides come to the table and engage in open two-way communication.
Presentation of your game plan
Restructuring is supported by a viable and comprehensive business plan that must be communicated effectively to creditors. A tool commonly used by creditors to assess the viability of a business plan is the cash flow forecast which covers the period during which the business plan is to be implemented and the repayment term during from which creditors can expect to collect their principal and interest / profits in full.
It is therefore important that any cash flow forecast presented to creditors is based on a set of realistic and verifiable assumptions, including operational performance, capital requirements and a collection schedule. Businesses must prepare for difficult questions regarding these assumptions and they must be willing to provide information, explanation and, where permitted by law, documentary evidence to creditors upon request. Simply put, a cash flow forecast should reflect the history of the company’s recovery and, if accompanied by a solid, well-argued narrative, can be a powerful way to gain support from creditors.
Negotiation is necessary to reach consensus
When a business is in trouble, there is a finite amount of money that can be distributed among stakeholders, including shareholders who are usually the last in line when it comes to company payments. The allocation of this limited resource is at the heart of any restructuring exercise. Each stakeholder has different motivations and a successful restructuring will need to balance these motivations, taking into account the priority of advocacy, in order to arrive at a plan that works for the majority of the parties involved.
If necessary, companies may choose to use a variety of formal business rescue mechanisms, such as settlement schemes and court management, to help reach a compromise. These mechanisms have rules in place, such as the threshold of support required to reach a compromise. For example, if a company wishes to undertake a plan of arrangement under section 366 of the Companies Act 2016, it will not need the unanimous support of the affected creditors; a majority of 75% of the total value of creditors (or category of creditors) voting in favor will complete the project.
For this negotiation to work, the parties must accept that they will not get everything they want from a restructuring (it is after all a compromise), but they must agree that the proposed actions will lead to a better recovery compared to the ultimate alternative – liquidation.
Restoring Confidence Through Restructuring
When a company undergoes restructuring, it is likely that a certain mistrust has developed between the company and its creditors. This could come from repeated payment promises that have not been kept or from non-disclosure of developments that have had a negative impact on the business.
A confidence deficit could have a direct impact on negotiations and even derail restructuring. To restore confidence, companies can choose to hire an outside advisor or set up an independent internal committee to guide the company through the restructuring. This advisor or committee would be seen as an honest middleman – someone who is not tainted with past actions and can negotiate on behalf of the company with a clean slate.
Once the restructuring has been accepted and moves into the implementation phase, borrowers should be prepared to undergo a more rigorous follow-up process by creditors after the restructuring. Instead of viewing this monitoring as a negative invasive action, they should view it as an additional pair of professional eyes to monitor whether the restructuring implementation is going as planned.
With the impact of Covid-19 being fully realized, it is likely that more and more companies will seek to restructure to ensure their survival. In fact, up to 28% of those polled in our Act Now to Recover survey have entered into compromise agreements with creditors to reduce liabilities over the past 12 months, indicating that companies are actively pursuing restructuring and that it is not a foreign concept for them. .
Businesses looking to find a new lease of life through restructuring must prepare for success by acting quickly to establish lines of communication and invest time and effort in building trust with creditors. Transparency goes a long way in times of distress, which can pay off with more attractive recovery options for all parties.
Lee Chui Sum is Transaction Partner and Joshua Jeyaraj is Transaction Manager at PwC Malaysia. This is the fourth in a five-part series on business takeovers.