Finance: COVID-19 and companies in financial distress - part one
In part one of her blog, lecturer and TC Finance Subject Controller Eleanor Poole CA explores options a company can take when they are in financial distress, linking these to content in the TC Finance course.
Throughout 2020, many areas of finance have been severely disrupted by COVID-19.
Something we have (unfortunately) grown accustomed to seeing in the news is companies falling into financial distress, entering administration or even being liquidated and wound up entirely.
Can we turn this business around?
To consider which of these pathways is most appropriate, we need to consider first, “can we turn this company around?” Can we expect to see this company returning to success and profit in the future? This may be achievable if the company expects to receive further contracts with customers in the future, if the company has valuable assets such as a recipe which can be revenue-generating going forwards, or if the reasons for the financial distress are only temporary.
Creditors may be concerned if they are owed money from a company in financial distress; there is potentially less chance for that company to repay in full what they owe. In these circumstances, creditors will consider taking legal action for the recovery of these debts, which can be a real concern for the companies in financial distress, especially if they think that there is an option to turn their fortunes around.
Company voluntary administration
If the company can be turned around, one option is to enter into a Company Voluntary Arrangement, or a ‘CVA’. This can be beneficial where the company in financial distress wants to focus on turning the business around, as opposed to placating angry creditors.
A CVA works by offering existing creditors Xp in the pound – essentially offering a partial repayment of their outstanding debt. A creditor may be offered 20p in the pound, so if they are owed £1,000, they will only receive £200 in total.
A creditor may choose to accept this as £200 guaranteed today is potentially more secure than nothing in the future. If the company in financial distress can return to profit and success, this means more business for the creditor. If they have supplied products to the company in the past, they may be willing to do so again in the future.
The company in financial distress may decide to offer Xp in the pound as it will be able to settle outstanding debts for less, enabling them to focus on the other pressing matters that are forcing them into financial woes. CVAs can also be arranged quite quickly, enabling both parties to move on with minimal costs and minimal fuss.
It is important to note here that legal action can still be brought against the company by their creditors. This legal action can be costly for both parties and can potentially result in the company being wound up.
Examples of companies that have used CVAs in the past include Revolution Bars Group, Pizza Hut and Poundstretcher.
Administration
Another option open to the company is to enter into administration. This is something we often read about on the news as it is a common path for companies to take.
With administration, the main feature of this path is that the “shutters come down” on the business; no legal action can be taken against the company, and no angry creditors can chase for their unpaid bills.
This is clearly of great use to a company that has angry creditors chasing for repayment of debts, so we can see why administration orders are often chosen above CVAs.
With administration orders, we have an administrator take over the affairs of the company. This administrator will run the business and make decisions about disposing of assets and potential redundancies. The administrator will also prepare a Statement of Affairs, detailing the assets the company currently owns, as well as the order in which creditors will be repaid (if at all). Reviewing this Statement of Affairs can enable a creditor to answer questions such as, will I get all my money back, because I’m higher in the priority list of creditors? Will I get only some of my money back? Could I end up getting no money at all because I’m a ‘less important’ creditor?
Administration orders don’t always signal the end of a company; several companies have successfully used administration orders before turning their businesses around to profitability, including companies such as HMV. These orders aren’t permanent and are only to be used as a temporary measure – either to bring the business back to profitability or to ensure as much money as possible is raised for creditors prior to liquidation.