How to deal with financially troubled businesses
With administrations and liquidations steadily on the rise, more businesses are finding themselves having to deal with the fact that their trading partner has fallen into potentially fatal financial strife.
From a practical perspective this can leave you with unpaid invoices, suffering damage from having a deal or partnership fall through and losing the benefit of a hard-negotiated contract.
However, savvy commercial investors are not grieving, but instead turning their mind to what opportunities have become available.
To explore these opportunities, you will most commonly need to deal with liquidators and administrators. This causes many to reconsider their strategy as it can be a daunting, uncertain process. Often the rules which apply to a normal transaction do not come into play, and the transaction’s landscape can be foreign.
However, by understanding the process and the obligations which guide the decisions made by liquidators and administrators you can identify and maximise the opportunities.
To make the best of a potentially bad situation, you will need to:
- understand the situation
- engage with the liquidator and administrator in such a way to maximise the prospects of a successful transaction
- continually assess, value and manage the risk
Understand the situation
When companies are in financial distress that goes beyond simple trading difficulties, there are a number of options which companies have available.
First, a voluntary administrator can be appointed to control a company’s affairs. Voluntary administration is a process where companies try to work out their difficulties using a commercial and practical approach. Administration is like calling in the doctor before the mortician.
Once a voluntary administrator is appointed to control a company’s affairs, at the end of a period of assessment, at least two meetings of creditors are held. At the second meeting, the creditors choose the outcome which they believe will best serve their own interests. While there are a number of possible outcomes, the most common are the execution of a deed of company arrangement or the liquidation of the company.
By comparison, liquidation is the process of selling the company’s assets until there is nothing left and the proceeds are distributed in accordance with the priorities in the Corporations Act 2001 (Cth). The de-registration of the company is usually inevitable.
Engage with the administrator/liquidator
Once an administrator or liquidator is appointed, the opportunity to purchase assets or a business at a great price becomes available.
An administrator and a liquidator both have the power to sell assets. Savvy commercial operators take advantage of the fact that often the company is often cash poor, and a quick sale or injection of cash can turn an otherwise dying business into something that can be saved or has a greater value as a whole. Great deals are possible, you just need to make sure you have a price which is an incentive enough to satisfy the liquidator that he or she has met their obligations to creditors.
However, do not approach the transaction with an ‘everything must go’ attitude. Administrators and liquidators are under strict obligations to sell assets for fair market value and can be held personally accountable to creditors if an asset sale was not in the best interests of the creditors as a whole (for example, by selling an asset for less than it was worth).
While liquidators are subject to the same sorts of controls as administrators concerning the value of sales, by this time the liquidator must sell or dispose of all the assets of the business – meaning that you can negotiate a little harder on price.
Also, you may find yourself in a position to propose a deed of company arrangement (DOCA). A DOCA can be a successful way to obtain assets or parts or the whole of the business at a great price. Be aware that timing is tight and draft DOCAs are not always acceptable at a creditors’ meeting.
Assess, value and manage the risk
When taking advantage of these sorts of opportunities, be prepared to take risks and factor these risks into the price you are willing to pay for the business or assets. Some things for you to keep in mind include:
- Remember that the administrator may not know much about the business as its appointment may only be days old. Do not confuse the administrator with the prior management of the company.
- Do not try to negotiate the sale agreement too much – assess the risks and fight for key commercial points. It often achieves little and just slows down the process. For example, accept that you will not be provided with any meaningful warranties or indemnities.
- Always be on notice: there must be a reason for the financial instability of the company. Whether it was personnel, trading conditions, contracts with suppliers, bad debts – any number of indicators may exist to suggest that the business may not be the steal you think it is. Do your due diligence, try and obtain warranties as high as the liquidator will go (which is unlikely to be far), and remember caveat emptor (buyer beware).
- Practically speaking, you are very unlikely to be able to rely on the material that is made available to you by the external administrators as accurate so make sure you independently verify as much information as possible. Examples include physical inspection of fixed assets and speaking with as many contractual parties of the company as possible.
- Analyse the key stakeholders and relationships of the company: Who are the customers, who are the suppliers, talk to as many customers and suppliers as possible to see whether they will support you should you purchase the business. Find out whether the reputation of the business has been irreversibly damaged.
- With the consent of the administrators, talk to the company’s employees. Will they stay with the company if you buy it? Do you understand the total liabilities you will be taking on if you offer to take over (some of) the employees. Make sure you know the total amount of accrued long service leave, personal leave and other entitlements that you will be taking on and factor this into the price you are willing to pay.
- Get searches of the Personal Property Securities Register done to understand which securities are registered over the assets of the company and to understand which assets you are likely to purchase at settlement. If there are several security providers, you may have to get several approvals to any deal you negotiate. Ideally, obtain formal releases from all secured parties at completion, however, given the tight timeframe, be prepared to settle the purchase and deal with formal releases after settlement.
- Understand that it is unlikely that all third party consents will have been obtained at completion. Try to talk to the third parties and get their in principle approval and obtain formal consents after settlement.
While buying from an administrator may seem risky, with the right advice and right approach, some risks can be minimised and you may be able to purchase a business or assets for a good price.