News

Business Exit Strategies

When providing advice to directors of companies facing a cash crisis, one of the options considered is whether the business should be sold.

Often the cause of the cash crisis is that the current owner(s) can’t continue to fund trading losses despite a potential turnaround looming, or don’t have the capacity to finance the working capital of a business that has grown. Therefore, business exit strategies should be considered.

Some of the key aspects to making such a decision are summarised below.

Business sale

The most common way of exiting a business is to sell it. Selling a business has advantages including maximising the value of the plant and equipment, stock and business goodwill and it often helps the employees of the business retain their employment, allowing for the transfer or avoidance of some employee liabilities.

However the decision to sell the business - and the process that follows - is often quite drawn out and uncertain and therefore, for a business in a cash crisis, not easily implemented. When looking to swiftly sell a business, the likely purchasers are:

employees
business partners, or
competitors.

We have seen examples of each of the above sales in administrations we have conducted. Critical to the success of such sales is having time to negotiate properly and provide good support to the financial statements and key underlying business agreements. The following is a list of key financial information a vendor of a business should have available to support a business sale:

past financial statements, reconciled as close as possible to the date of sale
sales data segmentation, showing key customers and seasonality
purchase data segmentation, showing key suppliers and critical supply agreements
stock listings showing stock levels and historical stock turnover patterns
details of employee entitlements, terms and conditions of employment and award structures etc.
valuations of the assets and stock
information about property ownership/leases, and
any franchising agreement(s) and licences granted.

Clearly, assimilating the above documents is a time-consuming exercise and if time is not readily available, agents and advisers should be engaged.

The key to a successful sale of a business in a cash crisis is to be realistic about price and have a clear understanding of the financial outcomes for all stakeholders if a timely sale cannot be achieved.

Controlled wind-down

In many cases, a sale of a business as a going concern cannot be achieved. In these cases—cash flow permitting—the business exit strategy to be considered is a controlled wind-down.

In these processes, a business closure date is set, cash flows are prepared to support trading until closure and then the business trades until this date, trying to run out all stock and consumables in the process.

The decisions relevant in this strategy are:

managing purchases – purchase only what is absolutely necessary
run out all stock – implement strategies to quit all stock
managing employees – be honest and open with staff, give notice of termination so that employee entitlements can be worked out, and help with employment transfers to competitors where possible
negotiate with landlords and leasing companies giving plenty of opportunities for new tenants to be found for leased premises
sell surplus assets in a controlled fashion, trying to retain only the assets necessary to keep the business operating
look to assign long-term agreements to competitors for mutual benefit, and
pay creditors quickly and return surplus stock to them if trading terms permit.

Ultimately the day comes when the business ceases and ideally all of the hard work of selling stock and assets has been completed, leaving only a small final clearing sale. We are seeing this approach increasingly adopted by directors who have recognised that a going concern sale is too hard to achieve or not realistic to implement.

Insolvency statistics point to more small business insolvencies, but maybe not in SA

Statistics released in October 2013 from the Australian Securities and Investments Commission (ASIC) reveal small businesses are under increasing pressure from inadequate cash flow.

“Our experience in South Australia is that over the past six months there has been a general softening in the number of formal insolvencies, and greater confidence in business investment decisions”

ASIC reported that nationwide 81% of businesses that became insolvent in 2012/2013 were small businesses with less than 20 employees.

The ASIC national statistics pointed to the construction sector as the worst affected, and the ‘other’ category - which is mainly comprised of personal service businesses - rating highly as well, with the retail sector not far behind.

The ASIC statistics point to the major causes of business failure being:

poor strategic management
inadequate cash flow, and
trading losses.

Although the ASIC statistics could be used to point to more gloom and doom, our experience in South Australia is that over the past six months there has been a general softening in the number of formal insolvencies, greater confidence in business investment decisions (e.g. such as purchasing assets we are listing for sale) and a greater willingness for banks to lend to businesses.

Whilst some comfort can be taken from these observations, we are still hearing and reading of business closures so it is still too early to draw conclusions about a long-lasting economic recovery.

Therefore, considering the ASIC statistics and observations, we pause to remind business proprietors to take care to be conservative with expenditure decisions and focus on cash flow to ensure that the early signs of business recovery we are seeing can be successfully translated into financial strength over the next 12 months.

Liquidator’s duty on sale of assets

It is generally perceived that liquidators and receivers sell assets at bargain prices causing a real loss of enterprise value.

Whilst it is true that in many cases assets sold in external administration achieve prices less than the directors will have wished for, the process a liquidator works through ensures that—in almost all cases—the price a business or asset sells for reflects the market value at the time of the sale, and that in reality, the loss of enterprise value had occurred in the events that led to the need for external administration.

”The process a liquidator works through ensures that—in almost all cases—the price a business or asset sells for reflects the market value at the time of the sale”

Prior to commenting on those checks and balances, we observe briefly some of the commercial difficulties an insolvent vendor has, compared to a solvent vendor, that impacts upon price. A company selling its assets or business in external administration:

will not be presenting a business for sale with a recent track record of profitable trading
cannot guarantee the future viability of the business and customer and supplier relationships
cannot offer customer warranties
cannot transfer critical staff as the key staff may be the departed directors, and
cannot engage in long term price and contract negotiations due to the costs of trading and the associated risks to value being lost during trading.

In the matter of Wentworth Metals Group Pty Ltd v Leigh and Owen (as liquidators of Bonython Metals Group Pty Ltd) [2013] FCA 349 (18 April 2013) the Federal Court was called upon to consider a business sale and ultimately refused an injunction to prevent the sale of company assets by a liquidator. In doing so the Court acknowledged that the commercial decisions of liquidators or trustees are often made in difficult circumstances.

The Court said it is not the case that a liquidator is under a legal duty to achieve “the best possible price” for the relevant asset (as required of receivers by s 420A of the Act).

It was said that in exercising their powers, liquidators are subject to duties including duties of skill and care and the common law duties owed by a fiduciary to the company, its creditors and its contributories.

The Court also said that it is important not to lose sight of the standard of conduct expected of liquidators, particularly where matters of commercial or business judgment are involved but it is not something that should be second-guessed by the Court.

The conclusions we highlight from this are that as a business approaches a financial crisis it is important for the directors to acknowledge the loss of economic value that has occurred, what the implications of this are on all stakeholders (the creditors in particular), and take early advice on the options that are available that may help in preserving value and minimising loss.

Mark Lieberenz appointed a Registered Liquidator

We are delighted to report that in October 2013 Mark Lieberenz was appointed by ASIC as a Registered Liquidator.

With Mark obtaining his registration, this brings the number of liquidators in our firm to three and is recognition of Mark’s 17 years insolvency experience gained in both Australia and Canada.