A Corporate Lifeline: For Businesses in Distress, There Are Still Options

By  Liz Pinnock, Director, RSM South Africa and Marco Carlizzi, Partner, RSM Italy PLG

In the world of modern business, it is natural that some organisations reach a point where they are forced to make hard decisions in order to keep the lights on. Whether it is due to debt, mismanagement, fraud, malpractice, or simply a failure to adapt to changing market trends, sometimes a business faces a crisis from which it cannot come back – at least, not without a little help. That is where corporate restructuring comes in.

The process of restructuring involves bringing in objective professionals who have experience in helping distressed businesses make the transition from crisis to long-term survival. Although, this idea is not new, the current economic climate has definitely made it a much more common occurrence. Covid-19 has thrust us into a world where businesses that were perfectly healthy and even thriving just weeks ago are being forced to take drastic action to simply survive.

Opening the door to a new way forward

For many companies, Covid-19 has stretched cash flow to its absolute limit. More alarmingly, distressed businesses may have to face the harsh reality that restructuring may be the only option left available to them.

However, restructuring is not always a crisis option. According to Marco Carlizzi, Partner, RSM Italy, there are two types of companies that are in a position to restructure. ‘In some cases, the business is operationally sound, but is experiencing pressures to save costs, streamline operational efficiencies, and optimise the business’, says Carlizzi. ‘Or you have what we’re seeing a lot of right now, which is a business that is financially distressed, and must either sell parts of the business, reduce staff, and reduce expenses to survive’.

Either way, it is important to look at the value that restructuring can bring, outside of the usual colloquial business jargon. On paper, restructuring can create a new way forward, a lifeline if you will, for businesses experiencing financial pressures. But there is a far greater impact. For businesses that are financially distressed, restructuring can offer a second chance.

The process begins

Corporate restructuring is complex and requires deep analytics of number of different aspects of the business, including robust financial data, economics, and tax and legal implications. In practice, if a business is looking to go through a restructuring process, the first thing they will be asked to do is to prepare and provide access to financial data.

Once that has been established, a restructuring adviser will typically:

• Conduct a thorough examination of the organisation’s consolidated financial statements
• Gain an understanding of the business’ group shareholding structure
• Analyse funding between the companies (intragroup)
• Determine if there’s an opportunity to apply corporate restructure rules under various tax legislations

The end game is to restructure the company on a tax neutral basis. If achieving tax neutral status is not in the cards, then the restructure becomes much more complex.

Once an adviser gains an understanding of where a company currently is, how do they help them get to where they want to go? Firstly, there are two questions that must be answered – what do the balance sheets look like now, and what do we want them to look like? The answers to these questions will inform the adviser as to what kind of transaction the business should pursue. Is it a merger of entities? Some form of share transaction? Once the desired result is agreed upon, then the adviser can guide the business through the process of implementing a legal framework.

Next steps

More often than not, an adviser will draft a position paper for the board. This paper will articulate the purpose of the restructure and how it will be achieved, including timelines, deliverables, and a cost/benefit ratio. This usually ends up being a substantial document for the board, designed to help them apply their minds, and it is best practice to provide two or three options.

In some instances, advisers may suggest triggering tax relief, whereas other times a business may not be in a position to do so. Often, advisers have mapped out the various options for a business, and from a legal perspective there may be a suite of agreements that support them. Once the board has considered and selected their preferred option, their legal adviser will draft all agreements (including tax clauses). The CFO of the business will provide the legal adviser with financials to support the agreements. In perfect synchronicity, the entity and its tax, business and legal advisers will need to deliver on all the agreements, from day one opening figures, stock, assets, and employees.

One of the legal ramifications is that if it is related to employees, all employee contracts will need to be re-drafted and signed. If it is a share transaction, then the business may have to consider change of control provisions.

The intangibles

There is a strong emotional element to restructuring. After all, this can be a heavy task for an organisation. There is a high level of complexity to navigate when examining a business down to its nuts and bolts. There is also an enormous amount at stake, and everyone in the room knows it. An organisation in the restructuring process is fighting for its life, and the people involved have likely poured a lot of their time, energy, and in many cases, even their love, into it.

‘Imagine you are telling an entrepreneur that their dream has failed’, says Carlizzi. ‘It can be emotionally exhausting for both parties. Many times, they are resistant to admit it’s over. The best you can do is encourage them to see that it’s not the end of the world, and then do what you can to help them reduce their liability’.

For businesses going through this process, it can be a very stressful time. A seasoned adviser is emotionally supportive. They are good communicators. They are good listeners. They will conduct regular discussions with their client to gain a better understanding of the fears and tensions they’re experiencing on a daily basis. It is their job to earn their client’s trust and help them rebuild their confidence – not just in the current state of their business, but in the future of their business as well.

Furthermore, if there is a merger involved, the work does not stop once entities have merged. In many cases, that is when the real work begins. A good adviser helps their client facilitate the cultural alignment of the business and helps employees from both entities to work better together.

Communication is key

The fundamental truth about restructuring is this – even though these negotiations typically involve analytical thinking, the best outcomes are born through creativity and an innovative mindset. There is a lot of problem solving involved to achieve the desired outcomes.

Businesses in restructure mode must be transparent, and their advisers must be available to support them and help them deliver their vision. Given the high stakes, an adviser has to understand everything, get a bird’s eye view, then dive into detail, before coming up with an adequate solution. For a company with many moving parts, that can be quite an undertaking.

‘Communication between the business and its advisers is absolutely critical with conversations being our greatest resource’, says Liz Pinnock, Partner, RSM South Africa. ‘For me it is key is to make sure that dialogues between myself and the business are as honest and open as possible’.

“A lot of times, our clients are not as direct as we really need them to be’, Pinnock continues. ‘They’ll call and ask for a copy of general regulations regarding lockdown, and maybe you’ll ask how they’re doing, make some small talk. This is where the relationship-building aspect comes into play, because it’s hard for people to ask for help’. The advisers who are best at this are the ones who are curious, and genuinely care for their clients.

Unlocking after lockdown

It is becoming increasingly obvious that we will emerge from the Covid-19 crisis into a whole new world order. By now we’ve heard, “We’re all in this together” a thousand times, and while that is true, it might be more accurate to say, “We’re all figuring this out together.” As the world moves beyond the React phase into Resilience, we are firmly turning our eye towards what lies beyond Covid-19.

And even when the outlook is optimistic, businesses we help still need someone to hold their hand through the process because it can be highly complex and intimidating. Ultimately, there is a very human aspect to this. Their business is something they have built, together with their employees, and they want to see it protected and preserved for the future.

‘Beyond the legal aspects to restructuring’, Pinnock concludes, ‘In the end, it is about building relationships. Our job is to help our clients look up, and to be positive and pragmatic about the outcomes we’re building together. It’s not just about surviving “The New Normal” – it’s about thriving in it’.