Restructuring insolvent firms

Restructuring occurs when a business significantly modifies its debt, operations, ownership, or structure to either improve or protect itself.

Restructuring is often but not always, a response to financial pressure felt by a business. It can also be an effective way of improving business performance for example, selling a cost centre.

So why should you want to restructure rather than close a financially distressed business? An operating business is worth more than its parts, but not in a clearance sale.

Assets such as goodwill and custom software have significant value to a continuing business but lose almost all of their value in liquidation. This is why liquidation rarely sees all creditors paid in full.

In some cases, a business has assets covering all of its debts but lacks cash to pay the debts that are due. Such business should be allowed to generate cash in the ordinary course of business to preserve value for itself and its creditors.

This way, the business can generate better value from its assets and investments than it would under an insolvency-driven auction, which carries higher risks for buyers.

In other cases, a business can pay its debts as they arise while also lacking assets to cover all its liabilities.

Here, it makes sense to play the long game as some debts may never become due and others will be resolved given sufficient time. It is not sensible to dismantle an operational business today because it may be unable to pay debts in the future.

The final consideration in support of restructuring is that liquidating a business can cost more than rescuing it. Closing a business turns a potential loss into a real loss, which need not always be the case.

Many of the factors that lead to financial distress can be addressed through better planning, management and time to justify seriously considering restructuring.

So how do you ensure a successful restructuring? Creditors need to appreciate they are in a prisoner’s dilemma and the way out requires goodwill and cooperation.

Individual creditors are often incentivised to act in ways that create subpar outcomes for all creditors. Creditors are always better off when they cooperate and coordinate with the company and each other in making decisions.

At a minimum, the company and its advisors will require time to frame and assess recovery proposals. Creditors should provide this time and not take adverse action against the business, which will jeopardise any possibility of recovery.

During this period, the company should avoid any action that may adversely affect the position of creditors. This goodwill and cooperation must continue into the implementation of any recovery plan.

A company would be shooting itself in the foot by approving a recovery plan and then withholding the goodwill and cooperation necessary for successful implementation.

Further, there must be transparency between the company and its creditors. The business should provide creditors with timely access to information regarding its financial position and prospects. This information enables creditors to properly evaluate and make informed decisions on the restructuring proposal.

Creditors must agree to keep this information confidential to enable disclosure and ensure recovery remains viable. A distressed business will likely require additional funding to aid its recovery.

This additional funding can only be obtained if the business promises to prioritise its payment before all its other debts. Creditors must be aware of and accept this.

Furthermore, a good proposal treats all similar creditors equally and all creditors fairly. Restructuring is often a bitter pill to swallow, but if fairly structured and implemented can stimulate great recovery for everyone’s benefit.

A good proposal does not adversely affect some creditors more than others simply because of their type of debt or because they voted against it.

Restructuring a business requires time and patience to pay off. Marvel Entertainment went from bankruptcy in 1996, to running history’s most successful movie franchise with revenues exceeding USD 25 billion.

Similarly, Apple went from nearly being wound up in 1997 to the first company in the world to achieve a trillion-dollar value. The restructuring plan once approved must be given sufficient time and space for implementation and to achieve results.

Restructuring when done right prevents the premature death of otherwise viable businesses. When properly planned, prudently implemented, and generally supported, restructuring can provide a breather to reorder affairs to enable recovery and even greater success.

Financial distress should not spell death for every business – as mentioned earlier; Apple and Marvel Entertainment went from insolvency to global powerhouses dominating their industries.

With the right expertise, goodwill, and patience, businesses can come back from near-death to be global industry leaders. Recovery is a win-win for all stakeholders of a business, from creditors to employees, which is why it continues gaining traction globally.