Part 1 of a 2-part series.
Did you know that not all companies enter external administration because of a lack of profitability?
Many external administrations happen because of factors completely unrelated to the profitability of its business, such as under capitalisation, impasse amongst executives/shareholders, bad investment decisions, fraudulent activities and so on.
In fact, if the underlying business demonstrates that it has prospects to continue to trade, then a “trade on” can provide the best return to all stakeholders.
“Trading on” as a good option
There are many upsides to the administrators successfully trading a business. A good trading outcome by the administrators demonstrates financial viability of the inherent business when the toxic impediments are removed from the business.
This can then assist the administrators in successfully restructuring or arranging a sale of the business, to salvage better economic value for stakeholders.
For example, almost all “trading” successfully undertaken by dVT Group was followed by a restructuring or a sale of the business. The impact of successful trading on the value of the business is often substantial. In a going concern sale as compared to a liquidation sale, we often see the former achieving 5 times, and in some cases, 10 times more value compared to the latter.
Taking the safer option
The reality is, however, that even when presented with a prima facie profitable business, not many administrators will trade on a business, especially not without a safety net such as a secured creditor.
This is mainly due to concerns over the inherent risks on the administrators as they are personally liable for trading expenses incurred. In addition, if the administrators’ trading resulted in material losses, they cannot simply wash up their losses in the pre-appointment asset pool.
They are also aware that many stakeholders often scrutinise the administrators’ trading, especially trading losses. Fair Entitlements Guarantee (FEG) is a very prominent example. However, when you also consider the tight time frames and often lack of reliable information in such matters, such decisions are often difficult to make.
Consequently, when most administrators are not confident that they have the required resources and the specific business knowledge to ensure the business trades profitably under their watch, they often take the passive, and often safer option to cease to trade and eventually let the company liquidate. Further, any trade is often complicated by such issues as secured creditors on stock.
Our preferred approach
At dVT Group, we often remind our counterparties and colleagues, as stated in the Corporations Act, that the purpose of a voluntary administration is to first maximise the chances of the company and its business continuing in existence, and only secondly to achieve a better return for creditors.
We have a track record of successfully trading businesses under a VA.
Below are some insights into a range of practical considerations to consider when evaluating whether a business should “trade on”:
Administrators are personally liable for all expenses incurred during their trading period. Therefore, having a well-rounded budget/cashflow is key, and building a contingency amount in the budget is also helpful.
The business can be subject to different trading terms. Often there is a misalignment between terms with its suppliers and its customers. Accordingly, the administrators need to swiftly identify temporary cash holes in the budget and find ways to mitigate the risks by exploring options such as external funding for trading.
It is necessary to have open communication with all stakeholders, as without sufficient support, no “trade on” is possible.
In recent trading of a pharmaceutical services business, dVT Group combatted the issue of significant misalignments in supplier and customer trading terms by finding temporary external funding for the business. This successfully traded the business out of its cash holes.
Trading progress then needs to be regularly monitored and compared against the initial budget.
To manage the risk, a stop-loss point needs to be identified. If the trading position drops below that point, then the administrators need to cease trading immediately.
In most cases, there are many capable employees remaining in the business who are willing and ready to assist the administrators. After all, successful trading and restructure of the business means continuity of their employment.
Therefore, an administrator needs to ensure these key staff members are engaged in the process going forward to achieve the required outcome.
This involves communication, treating employees with respect and setting clear expectations at the start of the process. It is then vital to hold yourself and them to the same standard when it comes to delivering what was promised.
dVT Group has found during past trading administrations that where healthy relationships were established with key employees/management by open and honest communications, those relationships were critical to the trading’s success.
It is also important to work with management to agree to a set of procedures for purchase orders, business decisions and management of staff, where responsibilities are clearly defined.
Once a clear plan is established, together with a budget and cashflow, it is essential to ensure that there are adequate controls to safeguard trading. These controls need to balance security for the administrator whilst also allowing the company to trade and not strangle operations.
We do not try and reinvent the wheel. If the business already has well-established processes such as payroll, employee reimbursements, leave procedures and purchase orders, we take advantage of what is already there and fine tune it, then put controls in place to safeguard.
In a recent appointment, dVT Group adopted the company’s existing HR, payroll and reimbursement software and put appropriate controls in place. As a result, we processed weekly reimbursements and fortnightly payroll to approximately 60 employees without delays. We could also assume the HR function with relative ease in managing leaves, onboarding and offboarding employees.
Supply of goods and services
During a short intervening trading period by the administrators, continuity of supply of goods and services is essential. The administrators need to swiftly identify a list of the most critical providers of goods and services to the business and forge good relationships with them by being proactive and transparent in communications with them.
In most cases, suppliers will try to leverage their positions and demand for things such as their outstanding invoices being paid; hence negotiations are often required. When negotiating with suppliers, the administrators need to be clear on the issues they are not prepared to compromise on and be flexible enough on the ones they are. The goal is to quickly determine whether the relationship is likely to hold or is otherwise beyond repair. From past experience, dVT Group have found that most suppliers are cooperative and flexible, as long as our pitch to them protects their post-appointment earnings and is commercially sound. After all, they have a long-term vested interest in seeing the business revitalised.
If new suppliers are required, the administrators need to quickly identify them and reach an agreement with them. A pro forma supplier agreement prepared in advance would often help speed up that process.
In addition to the many technical issues (purchase money security interests (PMSIs), trusts, competing security interests, priority of payments etc.), administrators need to adopt the correct mindset before committing to “trading on” a business.
To be continued ….. Part 2 of this series will be published in the coming months.
Should you wish to discuss any of the above, please contact Tony Hui on 02 9633 3333 or firstname.lastname@example.org.
dVT Group is a business advisory firm that specialises in business strategy, turnaround, forensic investigations, and insolvency (both corporate and personal).