Published on 15 July 2011 by Tony Groom
Many companies continue to be run even when they are insolvent to avoid triggering the personal guarantees of the directors and owners.
Some of these might be listed for sale or investment through brokers in the hope that the buyer or investor will release the directors from their personal guarantees.
While the broker’s sales/ investment memorandum might try to justify a valuation premium for the company, normally the interested party’s due diligence will get to the bottom of its financial situation. It is at this point that the issue of personal guarantees normally emerges and it is easy to ignore the primary reason for the directors wanting to sell or seek investment.
In spite of any personal guarantees, a buyer/ investor might still be interested even knowing the company is insolvent. Often directors are trying to protect their personal guarantees from being triggered as would occur in liquidation or an asset sale via pre-pack administration so negotiations focus on saving the company.
Very often personal guarantees are provided to secured creditors such as a bank to cover loans or overdrafts that are already protected by a debenture which provides for a fixed and floating charge over the company’s assets. In such cases the personal guarantee is often only triggered by liquidation when the bank is left with a shortfall.
In such circumstances the directors will benefit from new investors helping save the company rather than buying its assets via a pre-pack administration. It makes sense that new investors protect their new money such as by taking security and/or having a company voluntary arrangement (CVA) in place prior to investment. This avoids creditors holding them to ransom.
A recent example was a furniture business. An investor wanted to buy the business and assets via a pre-pack administration. This would have led to the bank having to ask the director to make good any shortfall under his personal guarantee. Instead the investor agreed to invest subject to approval of a CVA and him having security over future stock purchases. The creditors supported the CVA and the bank renewed its £180k overdraft facility and the investor’s money is now secure. Effectively the investor provided working capital to fund the company by providing a stock facility and the bank didn’t have to call on its guarantee.
In another example, an insolvent toy shop which was seeking investment, there were two interested parties who both understood the need for investment to avoid triggering a personal guarantee given to the bank by shareholders. The approach by each was very different with one party focusing on minimising their own exposure by insisting on a CVA while the other wanted to grow the business without the tarnish of insolvency. While the deal involved giving up more equity, a CVA was not needed.
Rescue and turnaround advisers argue that if the owners of a business in difficulty wish to sell or seek investment without triggering personal guarantees they would be advised to call in a rescue and turnaround adviser before putting the business on the market through a broker.
By having a restructuring plan in place, with or without a CVA the sale/ investment can be structured in a way that protects them and the buyer/ investor. It also avoids putting off interested parties who might be put off when the issue of personal guarantees is raised.