Insolvency in its simplest sense is a state where an entity cannot anymore fulfill its obligations or in short its debts. There are so many things that it can bring to a business should it choose to rear its ugly head and the expert team at AABRS.COM is here to help us understand them and hopefully guide us to making better decisions to minimize its fatal consequences.
Whether or not an entity is insolvent can be measured in two ways or tests as follows:
- The balance sheet test pertains to when the liabilities in the financial statements exceed the amount of assets that the company has at a given period, while
- The cash flow test is when the outflows are greater than the inflows of cash.
In both instances, it can be deduced that the company does not anymore have the capacity and the resources to repay their debts and should therefore consider options to fix that and even the dreaded liquidations.
The effects of being insolvent are quite numerous and below are a few of these:
- Budget Cuts – In order to save up for the needed payments, the corporate budget may have to be cut and certain expenditures and projects may be reduced if not scraped out altogether.
- Employee Layoffs – Another effect of insolvency could be the laying off of employees which is in relationship to budget cuts. Duties and responsibilities may have to be redistributed.
- Creditor Relationships – When an entity cannot fulfil its liabilities on time, it not only increases its interest expenses more but it also tarnishes the relationship with your creditors. You will tend to have a poor rating on your credit grade and history. Plus, lenders will be unlikely to lend to you in the future.
- Vendor Credibility – Likewise, your suppliers and vendors may be apprehensive to allow you to order and purchase from them on credit.
- Personal Liabilities – On the side of directors, they might be held liable up to their personal assets too if proven guilty of breaching and not following suit with their responsibility of putting creditor interest before everything else.
- Cessation of Business – The last and the most fatal consequence here would be the cessation and closing down of business. This can either be through voluntary means or through a forced winding up petition issued by court as brought about by disgruntled creditors.
So when insolvency is looming, AABRS.COM advises entities to act on it quickly and cautiously.
A Member’s Voluntary Liquidation (MVL) is called for by a solvent company that wishes to cease and wind up operations. By solvent this means that the entity is still able to meet its financial obligations for a foreseeable future. It is still operational and thus can still be earning sales and profits. In short it is “not” bankrupt. But why should a fully operational and profitable venture choose to close down?
Majority of the public believe that the only time for companies to close down and liquidate is when it becomes insolvent, bankrupt and broke. Contrary to this popular belief, not all liquidations are caused by the inability to repay debts. Should this be the case then a Creditor’s Voluntary Liquidation will be done instead. So let’s cut to the chase, when is an MVL often called for?
CASE # 1: RETIREMENT OF OWNERS OR DIRECTORS – There are cases when the owner as in the case of a sole proprietorship, partners as in the case of partnerships or directors as in the case of corporations would want to retire, close the business and receive their appropriate shares. An MVL is often an option here.
CASE # 2: ABSENCE OF HEIR OR SUCCESSOR – This is fairly common in family owned and run entities. There are instances when there is no successor either because the owners had no children or the children have tread on other ventures and occupations. An MVL s used to liquidate the assets oftentimes providing for the retirement of the parent owners.
CASE # 3: CESSATION OF ENTITY’S PURPOSE – There are many companies that have been established to serve a very specific purpose. Should this purpose be met completed or cease to exist then the business will have no more reason to continue with operations and since it is still solvent then an Member’s Voluntary Liquidation is necessary.
CASE # 4: COMPANY DISPUTES – Another is when there arises a dispute between directors and shareholders making it hard for the business to continue peacefully and professionally. If a team does not work then it becomes hard to meet goals.
CASE # 5: RECONSTRUCTION OF THE BUSINESS – There are also cases when the business has to return its excess capital to its shareholders through a capital distribution. To minimize excessive amounts of personal income tax and to aid in reconstruction of the entity, the Member’s Voluntary Liquidation or MVL may be used.
A Pre-Pack Administration is one of the many business recovery options available to companies who are facing financial difficulties and who are facing a possible need to liquidate in the near future. What separates a prepack from other methods of its kind is the fact that it does not seek to close down or liquidate the business but rather it seeks to reconstruct the company so that it can possibly recover and ultimately proceed with operations smoothly and better.
In a Pre-Pack Administration, part of or the entire entity is sold to a third party or even to one of the directors themselves. The company is then operated and held under a new management. In essence, it has been defined as a restructuring procedure that involves the sale of a company’s business, together with its assets, on a going concern basis.
For those entities who find themselves at a standstill atop a tightrope where the fall is deep and the finish line quite foggy and uncertain, a prepack can be a solution to help work things out. Why so? Read on.
First, a prepack does not liquidate the business. Again as mentioned earlier, it is sold under a new administration or management wholly or partially. Of course, this only means that the company does not have to close down and cease operations. Its going concern is strengthened and its life lengthened.
Second, employee layoffs are lowered down if not eradicated. Imagine if the company does liquidate. Everyone loses their jobs. In many pre-pack administration procedures, there could indeed be a few layoffs but such is something that the management can work with. Jobs are spared and saved.
Third, most creditors prefer this business recovery procedure. And now you wonder why. Wouldn’t they be happy to see the debtor company sell off its assets and have its proceeds distributed to the respective creditors? Maybe they do but that does not assure that they get to collect the amount due to them in full. What if they don’t get anything at all? Plus setting up a petition at court for a forced liquidation is a lengthy and expensive process. When the debtor continues operations and persists to recover, they have more chances at getting paid in full plus any interests that may be validly applicable.
A Pre-Pack Administration is indeed a beneficial business recovery option. You might want to consider it and add it to your list of options.
A relatively new business recovery option for many companies today refers to what we call the Pre-Packed Administration. In fact the use of such has been growing as many entities deem it a better choice in contrast to liquidations. Why so? Let’s figure it out together below.
A Pre-Packed Administration or more commonly referred to as pre-packs refer to the series of procedures and processes by which the business, it’s assets, liabilities and equity, in whole or in part are sold to a new management or administration to further its going concern. It is a kind of restructuring procedure to protect the assets, interests and employees of a company that might go insolvent or are in great financial turmoil.
Now why are pre-packs a better option? Read about its benefits as listed below:
- It allows for the entity to continue its operations without disruptions as the change that occurs only involves the management. When the entity goes under liquidation, it can be loud and public. Pre-packs are less of a headline.
- Depending on the new administration, as many jobs can be saved if not all. Imagine if the company liquidates, no job will be spared and everyone is laid odd. Under pre-packs there is less to no lay-offs although some staff may be transferred from one department to another as deemed necessary.
- Creditors prefer this choice as they will be provided with a better return. If the entity becomes insolvent and its assets sold, the payment of the whole debt cannot be ascertained. Also creditors would want to salvage as much as they could and if you continue business, you have a better chance to pay them off.
- Relationships between customers and vendors or suppliers can also be saved. There is less loss on confidence from them of the company.
- It gives the organization a chance to redeem itself, continue operations and make business boom under new minds and new management. There is a room for improvement, an area for growth and a chance at success.
- When the troubled organization needs funding to save the business, pre-pack administrations can provide it and since the purchase of the entire business is not necessary and buying only a part of it can be feasible, this is a good solution.
So is a pre-pack administration the best option for your corporate dilemma? It could be but it would be advisable to talk to your league of experts to better weigh all your options.
Whether you are a concerned creditor, a worried employee, a curious public eye or the owner of the business itself, it is important for you to know the illuminating signs of a possible insolvency. You have to be aware so you will know how to act on it, what the best course of action is, will you still have anything to about it or is it a gone deal and how you will protect everyone’s interests best. To help us with this, AABRS experts have given us a list of this red flag signs that will help tell if a company is insolvent or is approaching to be one.
First and foremost, let us define insolvency. It is where an organization or individual cannot anymore meet its financial obligations when they mature or become due. In simple terms it is the inability of a debtor to pay their debts or in this case the inability of the company to pay their liabilities. There are actually two kinds to it:
CASH FLOW INSOLVENCY is where the company is not liquid enough to pay their debts when they become due.
BALANCE SHEET INSOLVENCY is where the liabilities exceed the assets as seen in the financial statements.
Now how do you tell if a company is insolvent? Here are four of the many signs:
- A delay in or complete inability to pay tax liabilities is one clear factor. This can entail that the business does not have enough resources or is not liquid enough to produce payment. Sometimes this can be attributed to employee fault but if it happens a lot of times and consecutively then be wary.
- Bounced checks are another. It is unlikely for businesses that are doing good to issue one. They will always see to it that such occurrences seldom happen or do not happen at all. Why else would their accounts be zeroed out?
- Employee layoffs are another. One of the most basic actions that businesspeople do in a looming insolvency is cut on costs in order to lessen disbursements. Cutting down on the labour force and passing their tasks to another’s job description is one clear sign.
- Poor documentation and record keeping is part of our list. When everyone is so concerned at keeping their heads above the water, they tend to put filing and document organization at the bottom of their lists. These are unintentional but there too are those who do it intentionally to confuse and bury the problem.
Insolvency has often been defined as a state where an individual, entity, organization or company can no longer meet its obligations and liabilities to its creditors or lenders. It can also mean a position where the amount of liabilities exceeds the amount of assets. In short and to put it simply, it is the inability to pay one’s debts. For companies especially, insolvency is such a big issue and one that is highly avoided by all means possible. So you ask. Are there any warning signs to watch out for to avoid such much dreaded state? Our friendly experts from www.aabrs.com have got some useful insights for us. Read on up on five of these and discover for yourselves.
- A negative cash flow should be a warning sign although it does not on itself signify insolvency. Cash flow statements indicate how much inflows and outflows a company has. Sometimes even if the business has good and increasing sales standing with constantly stable expenditures it can still have low inflows as is the case when it has more sales on credit which are mostly unpaid for a long time.
- Delay in payments to suppliers and to government entities. Most companies will have a date or a set of dates set as to when it will pay off its suppliers and when it will be remitting its withholdings to the appropriate regulatory body. These schedules are part of a routine and deviation from such can mean a red flag. Oftentimes when businesses are in a financial distress they try to delay their payments to improve short term cash flows.
- Missed payments. If not delayed, you miss out on payments. Companies that are unable to timely pay for what they owe can signify lack of resources to do so. This one is basically a no brainer. If you can afford then why can’t you pay right?
- A Winding up Petition is one clear sign. Creditors who often initiate this seek to get payment from the owing party which can be achieved through a winding up petition. This action can freeze up corporate bank accounts and assets.
- Inability to pay one’s employees is also a clear and visible red flag. As businesspeople you know very well the value of your staff and that your failure to provide for their salaries can upset them leading to degraded work. Not being able to pay them can mean you are going down the road to insolvency or you may already be there.
With the current economic situation, a lot of companies are struggling to keep their business afloat. And quite a number of them continue to do business without getting any consultation from financial experts leaving them with huge amounts of debt. In turn, creditors will chase them up for payments. If and when the company is still unable to pay the creditors after a few attempts to collect, then the creditors can file a winding up petition at court. What it means is that, after investigation the court can order compulsory liquidation of the company in order for them to pay the creditor/s. Once the winding up petition (WUP) has been issued, the company will be given 7 days to act. This situation should be prevented at all cost because once a petition is filed; all your bank accounts will be frozen. In 7 days you have to settle your debt with the creditors, this will make it even harder to pay if your accounts are frozen. After that, if you haven’t paid up, then your company will then go through liquidation so that the creditors will get paid.
Just like any case, there are ways to fight this. If you think that the creditor’s claim is unreasonable, then you should hire a solicitor to defend your company and get the petition adjourned. If you believe that your company still has a good chance to recover from debt, then your solicitor can also request for an administration order to be granted. What this means is that, a licensed insolvency practitioner will be appointed as administrator of the business. He or she will then place strategies in order to push the business forward with a goal to get the most value out of the company’s assets. When the company reaches a reasonable market value, it can then be sold or have the assets liquidated. It has the same goal as with winding up, to pay the creditors.
Once the court grants the winding up order, there is nothing that you can do at this point. The court will appoint an Official Receiver (OR), who will be tasked to liquidate all assets of the company. The OR has 12 weeks to decide whether he will retain the case or pass it on to an insolvency practitioner (IP). During which the directors will also be under investigation if they had done any illegal trade since the petition was issued. If so, legal measures will be filed against the director. This is a very serious offense and if proven guilty, you will not be allowed to become a director to any company for 15 years.
If you have financial problems now, it is best to consult a solicitor or financial planner before your creditors will take extreme measures such as WUP against you.
The first case I encountered pre pack administration was when I was still in Australia. As you may all know, Australia is known as a wine country. Obviously because of all the wineries spread across the country. One particular winery was having financial trouble since competition was pretty fierce; they had a hard time keeping up with the wine-making business. Hence, they went into voluntary administration.
What happens when a company is into administration?
What this means is that, a consultancy firm will take over the company on behalf of the owners because they are no longer able to bring the company to full throttle. The appointed administrators will be the one who will run the business on their behalf. They will assess the overall financial situation of the company. Administrators will find any strength in the hope of getting the business back in shape. They will find a way to make the business profitable, earn a bit more value, and when it does then the option to liquidate or to sell the business as a whole to a buyer will then take place.
In some cases, the business and assets are pre-packed and ready to be sold to a buyer, usually another company in the same field of business who will take over operations or dissolve the company entirely and just absorb the assets into the mother company, thereby eliminating competition. An insolvency practitioner will also be hired to act as administrator in order to ensure a smooth transition.
How to hire administrators
Some firms offer free consultation and evaluation of a business before you hire their services while some firms charge you for a fee. Either way, get a good scope of what each firm can do for you and then meet with your fellow directors so you can decide which firm you will hire. A shareholders and creditors meeting is held in order to nominate and vote for an administrator. Once appointed, the administrator will give his proposal to the company as to what his plans are in order to bring the company forward. He will present some strategies and tactics to help save the company. The group will then decide and vote again if they agree with the proposal or not. Once the proposal has been accepted then implementation of the new procedures and strategies will commence.
So what is a pre-packed administration you may ask? This process primarily aims to promote recovery of business entities that are likely to be under insolvency and therefore is at a high risk of dissolution and/or bankruptcy. Here, the company is sold off to current directors, a trade buyer or a third party in such a way that daily operations remain as is even if ownership has been transferred already. A pre-packed administration therefore permits and allows for business continuity, preserves corporate goodwill, saves jobs and keeps the business afloat.
According to the Association of Business Recovery Professionals in the UK, pre packs are arrangements under which the sale of all or part of a company’s business or assets is negotiated with a purchase prior to the appointment of an administrator and the administrator effects the sale immediately or shortly after his appointment.
why do certain companies choose to make a pre pack administration? Here are some of the reasons why:
- As stated earlier it aims to rescue entities that are at risk of insolvency and bankruptcy. No one would ever want that and a solution out of such unwanted possibilities is always a thing worth considering.
- It provides business continuity. Besides as stated in the Going Concern principle, individuals or a group thereof put up a business and see it to run indefinitely. No one invests and aspires to loose in the first place.
- It allows and provides for the attainment of better outcome and output scenarios for creditors as when compared to liquidation or winding up of business. In the former, business runs its usual course only with a change in ownership thereby retaining creditor interest. In the latter, creditors will have no choice to receive whatever is left of the company if there is any.
- It also helps preserve jobs. Pre-packs however do not guarantee that no one is laid off but it is able to keep more people employed. On the other hand if the entity winds up its affairs everyone loses their jobs and sources of income. No one is spared. It is about choosing the lesser of two evils and where one will gain more benefits than harm.
- Also, the value of the business is retained with a pre-packed administration because you are reviving something and saving what could be spared rather than throwing away everything later on because you acted too late.