What is business restructuring and when is a business restructuring used?
A business restructuring is where a business renegotiates its contractual arrangements with creditors (and possibly other stakeholders). The renegotiation may involve a formal insolvency process such as an Administration or Company Voluntary Arrangement.
A business restructuring may be required when the business can see that, without action, it will be unable to pay what it owes when the debts are due.
What are the benefits of business restructuring?
The principal benefit of a business restructuring is that it can help avoid a terminal insolvency process such as liquidation.
In a liquidation the business is likely to have to cease trading. The impact of a liquidation is often negative for most stakeholders: employees and directors lose their jobs; suppliers lose a customer; landlords lose a tenant; HMRC loses tax revenue; the community loses a source of wealth.
Importantly, the assets (including the skills and experience of employees) of a trading, and potentially profitable, business are normally much more valuable than the physical assets and book debts of a business on liquidation. Not only does the value of a company’s assets fall when it ceases trading, further claims against the company will also crystallise. There will be substantial redundancy and notice claims from employees and various parties (including landlords) may have claims for breach of contract. All of this means that creditors are less much less likely to receive payment for anything they are owed.
A business restructuring’s central aim is to avoid all this and to put the business back on a sure footing.
When can a business be restructured?
What are the required conditions/circumstances for a business restructuring?
For a business restructuring to work it is essential that:
- there is a viable core business. i.e. the stakeholders must be persuaded that the business can make profits in the future;
- the business must be in a position where it can continue trading while the restructuring is formulated and implemented i.e. it must have access to cash and some certainty about essential operational supplies;
- stakeholders generally must be supportive of the business and have a desire to see it survive.
At what point should a business be restructured?
The bigger the problems a business has the narrower the options available for restructuring it will be and the more drastic the remedies will need to become.
Business restructuring should begin as early as possible to have the best chance of success. This is for several reasons: more cash is available to fund trading so that restructuring options can be more fully explored; more time is available so remedies that act over a longer term can be considered; relationships with key stakeholders are likely to be better.
If action is left too late there may be no realistic choice but to make redundancies and close the business.
What kind of problems can business restructuring help to deal with?
Business restructuring is used where the management see that the company is not going to be able to pay its debts on time.
However, it is important to understand the causes of the business’ financial issues:
- Sometimes these cash-flow issues are temporary and may have been caused by an unforeseeable one-off event external to the business. The management, stakeholders and creditors may be able to come to an agreement about how to restructure the company’s agreements and/or refinance its debts. This may include deferring or writing off a portion of the debt.
- If, however, the cause of the problems is internal to the business simply restructuring the debt will not, in isolation, solve the problem. The business restructuring plan will need to include measures to deal with the operational causes.
What are the options for restructuring a struggling business?
If a business is struggling it may be able to reach informal arrangements with stakeholders. If not, it may need to use formal insolvency rescue procedures such as Company Voluntary Arrangement or Administration.
What informal business restructuring arrangements can be made?
There is every reason for all stakeholders to agree to informal business restructuring arrangements with a company. These would not involve a formal rescue procedure. They may include provisions for the rescheduling of repayment dates, for the sale of non-core business assets or for the injection of equity capital.
Stakeholders should be aware that, should a formal process be required, it is unlikely that creditors will ever be paid in full even if the business is rescued. The business is already in difficultly. Not only will the company need to pay its ordinary trading costs but it will also have to pay the costs of the procedure too. (As a consequence of this it follows that shareholder value will have effectively been extinguished and so the rights of the creditors tend to outweigh the interests of the shareholders.) A formal insolvency will almost certainly, then, lead to a loss of value in the business and therefore a lower return for creditors.
In the case of a small company a formal rescue procedure such as CVA or an Administration may be financially out of reach. If so, and if the business cannot somehow be turned around, there may no rescue options available which would mean a Creditors Voluntary Liquidation (CVL) is likely to be the only other option available. A CVL will mean that the company ceases trading altogether. Asset recoveries in this scenario are likely to be much worse than if the business continues.
It is then, particularly with small companies, in the interests of all shareholders, creditors, suppliers and employees to try to find a way to avoid formal insolvency if at all possible. If these stakeholders can be persuaded, they may be willing to be patient or enter into informal agreements.
One of the drawbacks with informal arrangements is that the creditor may not be legally committed to the restructuring and could therefore back out and commence recovery action against the company. Also, creditors are less likely to be willing to accept restructured payments unless they know that other creditors are ‘sharing the pain’.
What formal insolvency processes are available for a business restructuring?
The main formal insolvency processes available for a business restructuring are:
- Company Voluntary Arrangement – A common procedure which can allow the business to continue to trade under the power of the directors while restructuring solutions are explored.
- Administration – A common procedure in which the company may trade but is under the overall control of an Insolvency Practitioner.
- Schemes of Arrangement – This is not technically an insolvency procedure as it is a statutory procedure under the Companies Act, however, it is used in insolvency scenarios. It is rarely used with smaller companies as the costs of the required court applications can make it prohibitive.
Why might a formal insolvency process be necessary for a business restructuring?
If a business runs out of cash it will quickly begin to affect its operations: the bank may suspend cards and accounts and could look to appoint receivers; there may be staffing issues; utilities may be cut off; landlords may look to seize goods; creditors may petition for a winding up, suppliers may take back their goods. If vital services are denied to a business its trade can come to a halt very suddenly.
If directors can’t be confident that stakeholders aren’t going to take action they may need to enter formal insolvency in order to protect trading (and therefore business value).
Both CVA and Administration come with a statutory moratorium. A moratorium can prevent creditors taking action against the company for a period of time. Utility companies and other essential suppliers can also be required to keep supplying the company. In this way the business may be able to continue to trade where it would otherwise have been forced to stop.
Another reason for a formal insolvency process may be that, while the company has widespread support from stakeholders, some creditors be not be supportive. In a formal insolvency, creditors with similar rights are treated equally. This means that, if the general body of creditors agree a restructuring plan, a dissenting creditor can be bound by the plan even if they don’t give their consent to it. They will be prevented from pursuing the company for what they are owed and will have to accept the payments agreed under the plan.
Other questions about business restructuring
Can a company continue to trade when in business restructuring?
Yes, it can. All of the options outlined above allow for a business to continue to trade during the restructuring.
How long does a business restructuring take?
This will depend on the situation:
- One strategy that is commonly used is a pre-pack Administration sale. In a pre-pack the whole business is often sold on day one of the Administration so the business spends almost no time in formal insolvency. It goes without saying that some preparation time is required to set up the sale and the Administration itself will continue for some time to collect the sale proceeds and distribute them to creditors.
- At the other end of the scale a Company Voluntary Arrangement may commonly last for 5 years or even more as the business makes regular contributions to creditors from its trading profits.
What happens if none of the business restructuring procedures are available?
When a business is struggling the best option is to try to turn it around by making operational changes early. If this is left too late or if the business suffers an unexpected financial bit the only it may not be possible to restructure the business. If this is the case the business will probably need to cease trading and a Creditors Voluntary Liquidation is the most likely way forward. It is important that directors deal proactively will this situation.
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