How To Successfully Sell An Insolvent Business
The latest figures released by the Insolvency Service for the first quarter of the year show that corporate insolvencies rose 4.5% compared with the final quarter of 2016, and were 5.3% higher than the same quarter last year. The official figures also indicate that Q1 2017 was the third consecutive quarter that the number of business insolvencies has increased.
Breaking down the data, an estimated 3,967 companies entered insolvency in the first quarter of the year, 2,693 of which were creditors’ voluntary liquidations (making up 68% of all insolvencies), 836 were compulsory liquidations (21%) and 438 were other types of insolvencies (11%).
Although corporate insolvencies are at near record lows, the uncertainty caused by the Brexit vote, high levels of inflation and the sharp fall in the value of the pound are making it increasingly difficult for the UK economy, which is taking its toll on businesses. Tough trading environments are pushing more businesses into insolvency.
Faced with a situation where the business is running out of money, fast, there are a number of options available to directors, such as restructuring company debt to manageable levels to continue trading as a going concern (this is normally only an option if you tackle the issues early on), raising finance or a sale.
For directors who have decided to sell their business which is in danger of insolvency, the best course of action is to act quickly as once the company is insolvent, that is, it can’t pay its debts as they fall due and its liabilities exceed the total value of its assets, its value becomes questionable and it becomes difficult to find a buyer.
It’s crucial to get valuations of the business and its assets on both a liquidation basis as well as on a going concern basis. This will help to negotiate a suitable sale price. However, getting a good price for the business is not just dependent on the assets of the business, but the type of business, the current market for this type of the business as well as the availability of buyers.
The sale of a going concern typically gets a better price than liquidation. Frequently, however, this cannot be achieved and the business has to be broken up and sold piecemeal following closure to maximise returns to creditors. In this scenario, the proceeds of the sale is distributed amongst creditors and fees and expenses are deducted.
The simple fact is that an insolvent company usually has more value for the directors than anyone else.
When a company is in financial distress and, it seems tempting to sell assets at a discount. However, it’s vital to remember that when a company is approaching insolvency creditors’ interests must take priority. By law, once a company is insolvent, directors have a duty to act in a responsible way and in the best interests of creditors rather than shareholders. This includes making the tough decision to stop trading and to take steps to minimise the potential loss to creditors. This will almost certainly involve appointing an insolvency practitioner or IP to start an formal insolvency procedure and, in the meantime, ceasing to pay creditors or place new orders.
When the company enters a formal insolvency process, director conduct and the transactions entered into are scrutinised by the IP. Directors could be held personally liable and ordered to pay a financial contribution to the company. They could also face disqualification of up to 15 years.
This process is very different to a regular business sale; the main difference being that an administration sale the business or assets are sold “as seen” and no warranties or indemnities are given. Title is also transferred on the same basis. In this scenario, it’s the responsibility of the buyer to make sure that he or she has title to assets bought. If it should emerge later that an asset was sold without good title, for instance goods can be subject to retention of title, then it’s the buyer’s responsibility, rather than that of the administrator or the company. A company in administration ceases to exist within 12 months following completion. Therefore, there is no entity to support an indemnity or guarantee.
Pre-Pack Administration Sale
This type of sale is different to a regular administration sale as negotiations are frequently carried out confidentially because approaching insolvency may damage the sale of the business as a going concern. This is particularly the case in the sale of service companies, where there’s a risk of skilled staff leaving the company for other employment if they hear rumours that the business is failing.
A pre-pack sale normally involves selling the business and assets of the old company to existing management who then form a new company. The assets, work in progress and debtor book can all be paid for over a period of time. The sale is arranged before the administrator or IP is appointed and as a result he or she must ensure that a full independent valuation of the business takes place and that the deal is a better option for creditors than liquidation.
The benefits of a pre-pack sale are that it’s the best way of preserving value for the business, creditors and directors. When a company enters administration this can cause a certain amount of disruption that can result in it ceasing to operate. In contrast, a pre-pack administration can produce a smooth transition, with creditors paid off from funds generated from the sale of assets. The company is typically sold to its directors who are already familiar with the business, historic debts are written off, staff hold onto their jobs.
As a result of controversial pre-packs deals, SIP 16 was issued with guidance from the Insolvency Service that places administrators under a strict duty to provide information and all the relevant details to creditors shortly following a pre-pack sale.
Sale And Purchase Agreement
All sales, including administration and pre-pack sales, are subject to negotiations and,therefore, the terms agreed will be particular to the specific circumstances and sale agreements must be tailored accordingly.
This article was contributed by Mike Smith, director of Company Debt, a business insolvency consultancy that offers free and impartial advice to directors and company owners that have found themselves in financial trouble.