Business Survival using a Cash Flow Waterfall

November 28, 2017 Edward Dever

Cash flow is the life blood of all businesses.

There are many examples of business collapses due to cash flow deficiencies, particularly in seasonal businesses. Cash flow issues can occur for many reasons and may be exacerbated by the inability to obtain appropriate credit facilities for the business.

A cash flow waterfall is a very simple method of managing a business's cash flow during a restructuring to assist with its survival. At its core is the assumption that cash flow is insufficient to pay all outstandings and, therefore, cash must be allocated in a manner which best allows the business to continue. Some deferment of payments is essential.

Monthly cashflow cascades down a list of priority payments commencing with fixed costs such as rent, utilities, employee salaries and other priority payments. General creditors are then paid on an oldest to newest invoice basis to minimise the payables ageing schedule. Depending on cashflow levels, it may then be possible to keep general creditors within a payment period such as 30 or 60 days.

Creditors who are aware of the business's cash flow issues may be more willing to extend payment terms where they can see their invoices are being paid on a regular yet slow basis. It is generally not in anyone's interest that the business collapse.

There will always be creditors who wish to jump to a higher level of the waterfall and it is management's responsibility to manage their expectations. Priority given to one creditor may cause a stampede of other creditors demanding equal treatment.

It may also be necessary to deal with rumours regarding the solvency of the business. To do this effectively, you may need to create exceptions to the cashflow waterfall approach.

One business with severe cash flow issues that I restructured faced an interesting situation. Rumours of insolvency started spreading through one part of the country. As best as we could determine, the rumours centred around a particular group of trade creditors who were owed a limited amount of money but it had been outstanding for many months. A failure to stamp out these rumours may have caused angst amongst the broader creditor group in other parts of the country. By paying out these creditors in full, we were able to contain the rumours and continue to manage the other creditors using the cashflow waterfall mechanism.

Cash flow waterfalls work best in jurisdictions which are more debtor friendly. In these countries, civil proceedings may be arduous affairs and bankruptcy proceedings may be considered only as a last resort. These jurisdictions allow more latitude in negotiations with creditors than may be possible where trade debts can be easily enforced.

Directors of companies also need to be mindful of the responsibilities of trading while insolvent. In some Asian countries, this is less of an issue and there may be no personal liability placed upon directors for trading while insolvent. In some cases, it is lenders who are penalised for extending credit to insolvent companies rather than the directors. Legal advice is necessary to ensure compliance with local laws.

PELEN

November 2017

The content of this publication is intended to provide a general overview on matters which may be of interest. It is not intended to be comprehensive. It does not constitute advice in relation to particular circumstances nor does it constitute the provision of legal services, legal advice or financial product advice.

Restructuring Businesses - Knowing When to Hold and When to Fold

November 7, 2017 Edward Dever

Often while working on a restructuring, there is a point in time when you get a real sense of whether it will succeed or not.

What seem like endless meetings making no progress reach a point where seasoned advisers can determine with a reasonable degree of probability whether the business will survive or whether it will be consigned to the corporate scrap heap.

There are, however, no guarantees.

All successful restructurings require buy-in from stakeholders. This includes shareholders, management, lenders and other creditors as well as significant customers. When one or more of these groups or a significant member of any group is at odds with the restructuring proposal, the chances of success diminish.

Many restructurings involve a dilution of existing shareholders' holdings or a debt haircut or write-down by lenders and the agreement of both these groups is crucial to success.

Often, it is best to ensure that the banking personnel involved in the original lending are not part of the restructuring process to remove any emotional tension between the lender and the debtor's management.

I have seen restructurings fail or taken to the brink of failure for many reasons.

In one major restructuring involving the first ever public listing swap in that country's history, the new investor almost pulled out of the transaction when they discovered the founder's brother was still on the company's payroll. The fact that this person passed away five years earlier did not seem to bother the founder but was very troubling for the investor.

Restructurings can fail due to reluctance on the part of owners or management to recognise that the business environment has changed and the business in its current form is unlikely to ever be profitable. If agreement cannot be reached on the closure of unprofitable parts of the business, there may be little point continuing with the restructuring. Sentimentality has no place in restructurings.

At times, external issues determine the course of a restructuring. Economic and political events may impact on the business. As strange as it may seem, restructurings can fail due to issues such as alcoholism and other addictions on the part of business owners or management. Draining business cash flow to fund owners' personal lifestyles is another potential death knell for a restructuring. These personal issues can affect the business to the extent that a restructuring becomes non-viable. Some form of lifestyle adjustment by business owners is often inevitable if the business is to survive.

There may be examples where a restructuring can be brought to a successful conclusion without full commitment from all stakeholders but it would generally be the exception rather than the norm.

PELEN

November 2017

Thailand - 20 Years After The 1997 Financial Crisis

July 5, 2017 Edward Dever

Sunday July 2, 2017 marked the 20th anniversary of the floating of Thailand’s currency, the baht. This event is widely regarded as triggering the Asian Economic Crisis of 1997 throughout South East Asia engulfing the economies of Thailand, South Korea, Indonesia and the Philippines.

Known as the Tom Yum Gung crisis in Thailand, floating the currency was one of the final acts of a government which had exhausted the country’s foreign currency reserves in an ill-fated attempt to shore up the baht against waves of selling and protect a finance sector riddled with substandard loans.

At its low point in January 1998, the baht slumped to around 56 baht to the US dollar. The banking sector and most major corporations with significant foreign currency borrowings were insolvent. The International Monetary Fund coordinated a bail out which was later criticised for the austerity measures it imposed on the Thai government.

In Bangkok, one of the Mercedes-Benz dealers initiated what became known as the “Market for the Formerly Rich”. Buyers sifted through an array of luxury cars, jewellery and other boom time badges of opulence, heavily discounted to raise cash for those who had lost jobs or money on stock market investments.

A number of banks and over fifty finance companies were closed or merged with other institutions. Sales of loan portfolios and other bank assets were organised. Lehman Brothers, which itself collapsed in 2008, was heavily involved in this asset sell off.

Twenty years on, it may come as a surprise to learn that a number of the main banks and major conglomerates are still controlled by the same pre-1997 family groups. The ability to retain control in the face of extreme financial adversity is due to two main factors: the debtor-friendly legal system in Thailand and the tenacity and negotiation skills of these families and their executives.

In 1997, there was no formal rehabilitation procedure for companies. A rehabilitation amendment was added to the Bankruptcy Act in 1998. At the time, bankruptcy was considered an option in only a few rare cases. Insolvency was determined by a company’s historical balance sheet rather than the more realistic liquidity test. Restructurings were often completed outside the court process although, for a time, the Bank of Thailand assisted in coordinating meetings of companies and their creditors.

Companies often took an extremely hostile approach to restructuring with a number of debt standstill arrangements taking over a year to negotiate. Thai executives believed lengthy delays would allow negotiations to be finalised in a more favourable exchange rate climate. In many cases, they were correct.

In the years following restructuring, many Thai companies have taken a more conservative approach to debt, particularly unhedged foreign currency debt. They have also expanded beyond Thailand with investments in neighbouring countries and further afield in places such as Australia. Part of the rationale for this diversification would be the lacklustre Thai economy, particularly in the past ten years or so as Thailand has struggled under political uncertainty and military rule.

Should the events of 1997 be revisited, it is doubtful that creditors would fare any better. While the rehabilitation law remains in place, debtors would once again have the upper hand in any negotiations. Directors of companies in Thailand are generally not personally liable if a company trades while insolvent. So there is no incentive for companies to use the rehabilitation procedure. Tossing a set of the factory keys across the desk to your creditors, particularly foreign creditors, and asking them to take over the business would remain a highly effective means of retaining control and negotiating a favourable outcome.

In these circumstances, the restructuring era adage that, in practice, equity in Thailand ranks somewhere above unsecured debt and often above secured debt is likely to hold true once again.

PELEN

July 2017