Responding to the legacy debt of 2020.
The business community has had big challenges thrown at them over the past two months. Many business owners who have always had strong and successful businesses are suddenly finding themselves looking inwards at their business to assess its financial viability during these difficult times.
Many businesses have taken advantage of the government stimulus packages and have deferred debt to enable their business to survive until all government restrictions are eased.
However, business owners must consider: how will they pay the legacy debt of 2020 being the deferred debt following September 2020? They will no longer have the government stimulus support and many deferred creditors will start requiring repayments to commence again. Added to this mix is the possibility that the revenue for these businesses may not recover to the pre-COVID-19 figures.
One option that may be available is using the voluntary administration regime with the purpose of implementing a Deed of Company Arrangement (DOCA). This regime may well provide business owners with the relief that they need from the deferred debt.
So, what is a DOCA? A DOCA is a proposal put forward by company directors to provide creditors with a return that would be better than a winding up scenario. In avoiding the company being placed into liquidation it provides the opportunity for the company to continue to trade with control going back to directors.
To illustrate this, let's talk about a manufacturing business that was operating profitably before the pandemic hit but since then its revenue has decreased by around 50 percent. The director has done everything right: reduced expenses; got JobKeeper; negotiated rent-free periods and deferred rent amounts; attained an ATO repayment agreement; and negotiated new payment terms with suppliers. The new projections say they will now survive on a break-even position until September 2020.
However long-term cash flow projections tell a different story. After September 2020 1 revenue will be insufficient to repay the deferred debt and new debt. The business cannot survive. This is where the company could appoint a voluntary administrator to assist in a formal restructure through a DOCA proposal. Once appointed, the administrator would:
- secure the business assets
- trade on the business
- consider whether the ongoing trading of the business is viable
- determine what recoveries would be made in a liquidation scenario (to qualify the DOCA viability for creditors).
- assist the directors in formulating a DOCA proposal.
Once the DOCA proposal is presented to creditors at the second meeting of creditors, they will vote to accept the proposal or vote for the company to simply be placed into liquidation. For a resolution to be passed, it needs a majority in number and a majority in value of creditors to vote in favour of the resolution. Ordinarily creditors will vote for the outcome that provides a greater return to them.
A DOCA proposal is completely open as to how it can be formulated. It could be an upfront lump sum payment for creditors, a regular payment over time, or a percentage of the net profit generated by a business. This is integral to how directors can gain that business confidence. The business performance and the business's seasonal fluctuations are factored into a strategy that sees the company repay its debt deferred and outstanding debt. To put this into context, a few examples of how the proposal is formulated:
- Sufficient funds to satisfy employees redundancy entitlements are made available.
- No payments made by the company until February 2021. This allows the company a moratorium period to focus on improving business revenue rather than be preoccupied with how they are going to pay the old debt. It would also assist them in getting through the Christmas period where revenue is seasonally lower.
- The company would pay 50 percent of all net profit generated for the following 18 months. With the contributions linked directly to the net profit, it ensures that the company can afford the payments.
Critically, what the DOCA does in this example is it allows the business to continue to trade and in doing so the following is achieved:
- Employees keep their jobs.
- Creditors keep a customer.
- A landlord keeps a tenant.
- The business survives.
A voluntary administration process that results in a DOCA appointment can be actioned in as promptly as four to five weeks, which leaves a minimal disruption as possible on the business.
Now, not for a moment do I suggest that all businesses out there should immediately run to their closest Worrells office and appoint a voluntary administrator, many businesses will be able to make it through these difficult times with other solutions. This formal restructure process is specifically aimed at those businesses that have taken all the steps and found that the business's long-term viability may be a challenge without taking further proactive steps. Those businesses sitting idle until September 2020, assuming (and hoping) business will get better, will have a very big surprise once all the COVID-19 government support comes to an end. Whereas, businesses that use this time wisely to restructure their business-whether informally or formally-get the best chance of coming through these difficult times in good shape.
To see how the numbers play out in the scenario briefly outlined above, click here.Footnote
1 Government measures end on 25 September 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.