What external administrators consider when deciding whether to trade on a business
Worrells is often approached by insolvent companies hoping to restructure their affairs and avoid liquidation. Although Small Business Restructuring (SBR) has become a popular option for companies since its introduction in 2021, not every company is eligible due to the strict $1million of liabilities limit or having outstanding employee entitlements (commonly superannuation) that they cannot pay in order to qualify. Voluntary Administration (VA) is often the next-best alternative for insolvent companies that are ineligible for SBR.
Unlike SBR, VA results in the directors’ powers over the company ceasing, with the voluntary administrator taking control of the company’s assets, including its business. This means that one of the voluntary administrator’s first decisions on appointment is whether to trade on the company’s business during the VA. In making this decision, the voluntary administrator will consider several factors, including (but not limited to):
Is a Deed of Company Arrangement (DOCA) being proposed?
Is the business viable?
Are there sufficient resources available to fund trading?
Can the business be sold as a going concern?
Is a DOCA being proposed?
A DOCA is a binding agreement between a company and its creditors, generally intended to:
maximise the chances of the company or its business continuing in existence, and/or
result in a better return for the company’s creditors than a liquidation would.
A DOCA can be proposed by anyone, but it is typically proposed by a company’s director. Where a DOCA proposal is likely, maintaining the business with minimal disruption may be required. This often requires the voluntary administrator to continue trading the business during the VA period. Further information about DOCAs can be found via this link: Deed of Company Arrangement (DOCA): Process and Implications | Worrells
Is the business viable?
The viability of a company’s business should be assessed early in the appointment. To do so, the voluntary administrator will prepare a cash flow forecast to identify whether the company is expected to generate a cash surplus or cash loss during the VA period. This forecast will consider:
what cash the company currently has available,
what debtors are likely to pay to the company during the VA period,
how much income is expected to be generated from ongoing trade,
what payments must be made to continue trading (e.g., employee pay runs, supplier orders, GST and/or pay as you go withholding etc.),
whether the forecast is consistent with historical performance.
If a cash loss is expected, it may be necessary to consider whether certain costs can be reduced (e.g., terminating certain staff or finding cheaper suppliers). However, an expectation of a significant cash loss is a sign that the business may not be viable. The voluntary administrator may therefore opt to cease trading unless that loss can be mitigated.
The voluntary administrator is more likely to continue trading when a higher cash surplus is expected. While a cash surplus may indicate that the business is viable, other factors should also be considered, such as current market conditions and the business’s future trading prospects if a DOCA proposal were to be accepted.
Are there sufficient resources to fund trading?
In conjunction with the cash flow forecast, the voluntary administrator will spend the early days gathering as much information as possible about the company’s assets. Assets of particular importance are cash and those that can be converted into cash quickly, such as trade debtors and stock on hand.
Continuing to trade will be difficult if the company is not expected to have sufficient cash available to meet ongoing trading costs. Where cash may be insufficient, the voluntary administrator may look for alternative sources of funding, such as:
The director/s or an associated entity – this may be appropriate if a DOCA is to be proposed, which requires as minimal interruption to the business as possible.
A secured creditor over most or all of the company’s assets – the secured creditor may fund ongoing trade in certain circumstances if it will help reduce their financial loss from the company’s insolvency.
Key customers that may be reliant on the company’s business to sustain its own operations – the voluntary administrator may look to persuade key customers to pay for goods or services in advance to maintain cash flow and reduce the prospects of bad debts arising.
Government departments that ordinarily fund the company’s operations – Registered Training Organisations (RTOs), childcare centres (in some states), and indigenous organisations are common examples of businesses that may rely on state or federal government funding to operate.
Selling assets that are surplus to requirements – motor vehicles and other plant or equipment not actively used can be sold to provide additional cash for the voluntary administrator, and/or to reduce required finance payments if the assets are subject to finance.
Even if sufficient resources are available, continued trading may not be warranted. For example, trading on when a large cash loss is expected during the VA period may diminish the resources that could otherwise be available for distribution to creditors. Additionally, if the company is more likely than not to be placed into liquidation, continued trading may not be warranted unless doing so is expected to provide a commercial benefit to creditors. For example, the company may be due to receive a large payment on completion of a contract milestone that may increase the expected return to creditors.
Can the business be sold as a going concern?
A sale of the company’s business as a going concern may be warranted, particularly if no DOCA proposal is likely to be received from the director. The voluntary administrator may continue trading where there is genuine interest from prospective purchasers in acquiring the business. The voluntary administrator may engage a business broker to help facilitate the sale while the business continues operating.
Even when a sale of the business is possible, the voluntary administrator should still consider the business’s viability and available resources to ensure continued trading does not compromise the interests of the company’s creditors.
Conclusion
Deciding whether to continue trading during a VA is never a simple exercise for a voluntary administrator. Voluntary administrators must balance the potential benefits of preserving a company’s business with the risks of diminishing the assets of the company through ongoing losses. Ultimately, the decision centres on whether continued trading is expected to deliver a better result than an immediate shutdown.
The decision to place a company into external administration is difficult. If you or somebody you know is experiencing financial difficulties, Worrells can help you understand the options available. For a no-obligation, complimentary discussion, contact your local Worrells principal. Positive options start by having a conversation.
