“The Problem is not the Problem. The Problem is your attitude about the Problem”

~ Captain Jack Sparrow, Pirates of the Caribbean

This quote rings so true in the uncertain times that we are living in. There is no blueprint on how a business is to survive and emerge from the COVID-19 pandemic.

Against this backdrop, directors of companies will be faced with difficult decisions. They have fiduciary duties to act in the best interests of the company and to act with reasonable care, skill and diligence. The decisions that directors make now will be of critical importance as to whether the company will survive, whether the company will be regarded as carrying on its business recklessly in circumstances where it is trading insolently or whether the company will be finally wound up or placed under business rescue.

In order to assist you in navigating these issues, I have drawn upon my own experiences to provide some guidance to the process.

Step 1: Understand the current situation

What is required is an honest and brutal assessment of the current situation in which the business finds itself. As this is a very emotive and stressful process, businesses will often require objective and independent professionals, like RSM, to assist in analysing and understanding the business, and navigating the difficult and hard decisions to be made. Without such a process, in my view, the business will not be able to make an informed decision on its future.

The process will require a critical assessment of the operating environment. Of paramount importance will be the conserving of cash and reducing expenditure, the forecasting of revenue, profits and cash flow, whilst taking into account the impact of COVID-19. 

Thrown into the mix will be the need access to funding from banks, government grants or relief or shareholder support, and the effect that this will have on the profitability of the business over the next couple of years. 

An assessment of the workforce may necessitate some employees being retrained, others redirected, and some employees being made redundant. Some of the many considerations which the business would need to take into account in its deliberations include renegotiating payment terms for certain creditors and landlords, an analysis of provisions of contracts, and the possible renegotiation or the invoking of force majeure clauses, a consideration of business interruption insurance and the possibility of making a claim, the impact of digital solutions and the IT system and environment.

Step 2: Winding Up or Business Rescue

In order to avoid any further financial distress, and following on the outcome of the analysis in Step 1, it may be that the best solution for the business is to windup or to place itself in business rescue. The board of the company will have a duty to account to shareholders, creditors, employees and registered trade unions on such a decision.

Step 3: Restructuring of the business

If the outcome of step 1 suggests that the business requires a different strategy, one in which the words of Warren Buffett ring true - “should you find yourself in a leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks” - then I would suggest that the business consider a distressed merger or acquisition or restructuring, as a means of reimagining itself post COVID-19.

This strategy could help the business transition from crisis to long-term survival.

Distressed mergers and acquisitions

Following the economic fallout from lockdown, many businesses may choose to divest of certain assets in order to pay down debt or fund ongoing operations, and avoid going into liquidation or business rescue - a so-called “distressed merger and acquisition” transaction.

A distressed merger and acquisition is not too dissimilar from a traditional merger and acquisition, other than the timeframes are compacted, and the legal and commercial challenges for the buyer and the seller are exacerbated.

The divestment strategy should include:

  1. the preparation of a flexible and fair business valuation taking into account the effects of COVID 19
  2. Analysing optimal deal structures including the legal and tax implications thereof
  3. Assessing the pros and cons of appointing a dealmaker to identify a suitable buyer (a buyer in a similar market with similar products or outlook may result in a higher price)
  4. Legal and regulatory issues including change of control provisions, the impact of B-BBEE on the buyer, competition commission filings, approvals from the Reserve Bank, company filings, B-BBEE commission filings, etc,

The buyer may require a detailed or targeted due diligence, which, these days, would necessitate using data rooms and data analytics. Contractual warranties and indemnities would need to be negotiated in order to mitigate against any risks. 

In my experience, it is often better to prepare a non-binding letter of intent, also known as a term sheet or MOU, in order to set out the salient terms of the transaction, and the structure of the deal, and to make sure that the seller and the buyer are on the same page. This will save a lot of time and frustration in the long run, and will garner trust between the parties.

In addition, the parties will be forced to deal with any contentious issues upfront, like the purchase price and any adjustments thereto, as opposed to dealing with the issues at a later date when time and costs are against the parties. On signing of the non-binding letter of intent/term sheet/MOU, the necessary commercial agreements are prepared, including completing the legal, tax and financial due diligence, and the necessary applications are made for regulatory approval.

Restructure as a means of reimagining the future

Restructuring the business can create a lifeline for businesses experiencing financial pressure.

The period of the lockdown has allowed many companies to critically assess their operational structure and to determine whether there would be a possibility of streamlining operational efficiencies and reducing costs through restructuring.

Step 1 would have yielded the financial data necessary to assess the various restructuring options. Ideally, the restructuring should be achieved on a tax neutral basis using the corporate restructure provisions of the Income Tax Act. If it is not possible to apply the corporate restructure provisions, then the restructure of the business may become more complex.

In my experience, corporate restructurings involve either a reorganisation of the ownership of a company, the reallocation of assets, business or functions within a group of companies, the reorganisation of debt within a group, or the financial restructuring (replacing debt with equity and vice versa) of the business.

Restructuring is complex, and those involved in guiding a business through the process, require a deep knowledge and understanding of the various legal, tax and accounting issues.

Liz Pinnock

Head: Group Legal, Johannesburg

Related articles

A corporate lifeline: For businesses in distress

COVID-19 and B-BBEE