21 March 2015 | Daniel Terblanche
Investment Opportunities within Business Rescue
Considering the doom and gloom of the 2015/2016 budget it is useful to know that there is a new mechanism for entrepreneurs to securely invest their funds with a return that could not be secured through “normal loans”. During the past two and a half years of our involvement in business rescue assignments it has become evident that in any rescue regime, a degree of financial support is required from the commercial environment through the provision of additional funding to assist with the recovery of the businesses who are financially distressed.
It is clear that with the onset of globalization and markets being exposed to the effects of global recession and economic downturn, the fundamental principles on which business operate have changed substantially. Some businesses have thrived in this new context, whilst others have struggled to remain competitive, as evidenced by increasing trend of corporate failures. As a result, the concept of corporate renewal and business rescue has become an integral element of the strategy of organisations, especially those who are financially distressed.
When a company enters business rescue, section 135 of the Companies Act 71 of 2008 (“the Act”) provides for a very innovative mechanism in which the company may obtain new finance and credit. This is known as post-commencement finance (“PCF”). PCF is treated as a post commencement administration cost whereby the funder receives a super preferential status. Initially, banks and other financial institutions were reluctant to supply PCF to companies under business rescue as they did not want to increase their risk. It was also not clear whether commercial banks in South Africa would be prepared to take over the security of another bank/creditor and to further get control by advancing PCF.
The process of procuring PCF is less cumbersome under business rescue than for instance under liquidation circumstances where the practitioner would have to approach the High Court for such funding. The Act further provides that, should the enticement of the of this super preferential status fail to be of interest to financiers that the business rescue practitioner (“BRP”) may obtain finance secured by assets of the company. It is also possible to provide encumbered assets as security to PCF lenders where the value of the assets exceeds the encumbrance on it. In order to be able to negotiate PCF it is important for the BRP to ensure that there is a reliable cash flow forecast in place. Due to the lack of cash flow in the majority of BR assignments it is important to attend to daily cash-flows and forecasts.
This is one way of assessing the performance of the business. In some of the assignments that we have attended to we found that there were no pre-existing cash flow forecasts. As an investment mechanism, PCF can secure very attractive returns to lenders due to the perception that there is a high risk attached to such loans compared to normal commercial loans. The truth is, however, that by virtue of the super preferential nature of such loans, the extra security that may be provided by the BRP and the statutory protection afforded, PCF lenders often enjoy better protection under business rescue than “normal” lenders.
In a very established market in America the providers of debtor in possession facilities under Chapter 11 of the American Bankruptcy Code have been enjoying good returns during the past four decades by investing as distressed lenders.
It is important to attend to proper financial modeling of the company that must include a detailed cash-flow forecast in assessing a company’s PCF requirements. The BRP must understand the sensitivities relating to the cash-flow based on the history of the business and the impact of a possible liquidation on the PCF provider. The BRP must, in conjunction with his/her legal advisors, consider the contents of the loan agreement that will include the duration, pricing and fees relating to the loan which by its very nature may be substantially more onerous than run of the mill loan agreements.
The notion of so-called “vulture funding” and the concept of “loan to loan” are well established in other jurisdictions such as the USA where distressed investors earn above average returns and often take control of the equity in distressed companies by virtue of the funding provided.
At Mazars Recovery and Restructuring we follow a stringent vetting process when considering any assignment. One of the issues that we consider is the requirement of new finance and credit as part of our strategy to restructure the company in distress. We would not accept an assignment should there not be sufficient funding available to assist with the rescue of the company. Our conservative adjudication process has ensured that we do not struggle to secure new finance or credit from commercial banks or financiers. The result of the confidence shown by the financial institutions in our abilities within the business rescue industry can be seen in the 95% success rate we have had during the past 60 months.
It is time that South African entrepreneurs become aware of these opportunities, but it is also important to note that no lender should enter into any PCF agreement without attending to a proper due diligence and to include their own legal advisors in the process.