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Implications of new business rescue legislation for private equity in South Africa

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Z-Score graph reflects history up to 2002, and thereafter the turnaround plan ... The market for turnaround private equity is expected to increase in 2007. ... – PowerPoint PPT presentation

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Title: Implications of new business rescue legislation for private equity in South Africa


1
Implications of new business rescue legislation
for private equity in South AfricaPrivate
Equity World Africa 2006
Jan van der Walt CEO Turnaround Solutions Deputy
CEO Turnaround Management Association Southern
Africa 6 September 2006
Turnaround solutions for underperforming and
distressed businesses
The premier professional community dedicated to
corporate renewal and turnaround management
2
Implications of new business rescue legislation
for private equity in South Africa
  • Business rescue
  • New business rescue legislation
  • Implications for distressed portfolio companies
  • Implications for distressed situation investment
    opportunities

3
As a troubled business moves along the timeline,
costs increase, but the success rate and
management power decrease
BUSINESS RESCUE
Timeline of financial distress
Underperforming company
Distressed company
Management-led correction
Informal creditor workout
Business rescue
Liquidation
Failure
Failure
Failure
Highest success rate
High success rate
Low success rate
Failure
Turnaround stabilised, funded and fixed
Debts worked out and possible turnaround
Rescued sold/funded or turned around
Dissolved
If sold/funded but not yet turned around
If worked out but not yet turned around
Time
Informal processes
Formal processes
Low cost
High cost
Cost/Success rate
This is due to change with the introduction of
new business rescue legislation.
High success rate
High failure rate
Power of directors and management
High
None
4
Business rescue has a number of objectives and
benefits
BUSINESS RESCUE
  • The purpose of business rescue is to preserve the
    going concern value of a distressed firm, that is
    or is going insolvent but potentially viable,
    through
  • Refinancing/financial restructuring, or
  • Turnaround (including refinancing/financial
    restructuring), or
  • Keeping it afloat and selling it as a going
    concern (for turnaround/refinancing by the buyer)
  • A firm that enters business rescue and emerges
    intact may satisfy creditors' claims more
    effectively than a firm that is liquidated
  • Business rescue is meant to allow a distressed
    firm to
  • Satisfy claims of creditors
  • Continue in the economic stream i.e. source of
    business for other companies
  • Preserve jobs and create employment
  • Pay taxes

However, SAs business present antiquated
business rescue legislation does not achieve
these benefits
5
Business rescue, however, is not a silver bullet
for distressed companies - as illustrated by
overseas statistics
BUSINESS RESCUE
  • High cost
  • Direct costs represent 24 of book value on
    entering business rescue (Nachtman et al, 1999)
    but still less expensive than liquidation (the
    move towards pre-packaged from free-fall business
    rescue will reduce costs though)
  • Low success rate the USA experience
  • Baker Smith, President of Morris-Anderson "Since
    over 85 of businesses never successfully emerge
    with a confirmed plan of reorganization, the cure
    must be worse than the illness.  Most companies
    die in Chapter 11.  Unless a companys underlying
    problems are addressed with a turnaround plan or
    sale, Chapter 11 cant ultimately save them."
  • Many firms increase their investment expenditures
    only by very little in the first two years after
    a debt restructuring (James 1995)
  • In each of the first five years after emerging
    from business rescue, between 35 percent and 41
    percent of all firms have negative operating
    income (Hotchkiss 1995)
  • More than 75 percent of firms that complete debt
    restructurings emerge with a leverage ratio that
    is higher than industry median and most are still
    significantly more highly leveraged than before
    the onset of financial distress (Gilson 1997)
  • Furthermore, between one quarter and one third of
    all distressed firms re-enter financial distress
    within a few years after completing a debt
    restructuring (Hotchkiss 1995 and Gilson 1997)

6
The success rate of business rescue is low
because (1) it is wrongly deemed to be a measure
of last resort and (2) has too little emphasis on
turnaround
BUSINESS RESCUE
  • Why a low success rate?
  • Formal business rescue is expensive
  • To save costs, management-led correction and
    informal credit workout are still attempted when
    formal business rescue should already be taking
    place
  • Stigma of bankruptcy
  • In countries with a legacy of English law like
    SA, business rescue carries the stigma of
    bankruptcy, leading to loss of prestige, staff
    and customers
  • This is in contrast to Chapter 11 in the USA
    where bankruptcy carries less of a stigma
  • Resistance of directors and management
  • Less so with Chapter 11 in the USA where
    directors and managers remain in charge (DIP or
    debtor-in-possession principle)
  • But more so in non-Chapter 11 jurisdictions since
    directors and management lose control

As a result of the 3 points above, a business
tends to be too deep in the Failing Zone of the
Z-Score by the time that business rescue is
triggered (example of Z-Score to follow).
  • Focus on restructuring instead of turnaround
    inclusive of restructuring

7
Apart from new business rescue legislation, we
identified a number of key success factors for
business rescue in South Africa
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Avoid the need for business rescue Avoid formal business rescue by educating business in timeous and effective reaction to early warning signals of distress
Expedite business rescue if the need cannot be avoided A stronger legal deterrent to directors trading under insolvent conditions (in new Companies Act?) Avoid free-fall business rescue - dont start looking at solutions only once insolvent Instead, use pre-packaged business rescue Timeously devise a turnaround plan inclusive of financial restructuring and then invoke business rescue before real financial distress has set in This hybrid takes the form of the informal creditor workout with its low costs, but invokes business rescue to achieve the protection offered by the latter. 
8
Business rescue key success factors (2)
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Dont attempt to rescue a lost case The purpose of business rescue is to avoid making a Type 1 error Type 1 error to liquidate businesses that should be rescued Conversely, Type 2 error refers to attempting to rescue businesses that should be liquidated Cost of Type 2 error cost associated with the unsuccessful rescue attempt plus the cost of subsequent liquidation
These first 3 points can be illustrated by means
of the timeline of financial distress table on
the next slide.
9
The timeline of financial distress illustrates
how remedial processes are applied during
different stages
BUSINESS RESCUE
The stages and processes in the timeline of
financial distress
Informal Processes Informal Processes Informal Processes Insolvency Processes Insolvency Processes Insolvency Processes
Emerging problems Acute and worsening problems Acute and worsening problems Acute and worsening problems Insolvency but possible viability Insolvency and unlikely viability
Management-led correction Management-led correction Informal creditor workout Business rescue Business rescue Liquidation
Management-led correction Management-led correction Informal creditor workout Pre-packaged Free-fall Liquidation
No creditor and legal issues since the financial situation is not yet critical Critical financial situation but no creditor pressure, due to support from benevolent shareholders ( e.g. distressed government organisations, SOEs and companies with financial support from holding companies) Informal agreement between management and creditors (banks) to reduce indebtedness Terms of workout agreement dictates agenda Present none Present judicial management and Section 311 Compromise of Creditors Very low success rate Realisation of the distressed company's assets and the distribution of proceeds to its creditors
No creditor and legal issues since the financial situation is not yet critical Critical financial situation but no creditor pressure, due to support from benevolent shareholders ( e.g. distressed government organisations, SOEs and companies with financial support from holding companies) Informal agreement between management and creditors (banks) to reduce indebtedness Terms of workout agreement dictates agenda Future Invoked when not yet insolvent Higher success rate than free-fall Future Invoked once insolvent Lower success rate than pre-packaged Realisation of the distressed company's assets and the distribution of proceeds to its creditors
Management retains the initiative and controls the turnaround agenda Management retains the initiative and controls the turnaround agenda Banks hold the power Court-driven inflexible and expensive Court-driven inflexible and expensive Court-driven inflexible and expensive
The timeline of financial distress is adapted and
extended from Matthias Kahl, Economic distress,
financial distress, and dynamic liquidation,
Journal of Finance 62 (February 2002)
pp.135-168 Used by the G10s Contact Group on the
Legal and Institutional Underpinnings of the
International Financial System to describe
insolvency arrangements and contract
enforceability
10
Business rescue key success factors (3)
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Turnaround, not mere restructuring Financial restructuring alone is OK if EBITDA/operating profit is positive, but losses are incurred due to the interest burden But businesses with strategic, organisational and operational challenges require more than restructuring to survive If distressed businesses are not stabilised and the underlying causes of distress are not fixed through turnaround action, the business will not survive restructuring Business can in legal terms be rescued by selling it but that still leaves turnaround to the buyer
Unless the business is fixed, "business rescue"
postpones the inevitable.
11
Business rescue key success factors (4)
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Turnaround finance Need for a stronger turnaround private equity industry in South Africa that Not only invests in underperforming businesses and businesses requiring financial restructuring but also invests in distressed businesses too New business rescue legislation will stimulate the market for distressed situation private equity
Business rescue cannot happen without a cheque
book.
12
Business rescue key success factors (5)
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Organised industry Turnaround Management Association - Southern Africa Promotion of the turnaround and business rescue industries Information exchange, networking, education and raising the standards of turnaround across both the informal and formal sectors
Education Education of industry and government through TMA-SA Educational conferences like this one today Certified Turnaround Professional (CTP) qualification TMA-SAs future programme to educate turnaround practitioners Exam on (1) turnaround management (2) financial, managerial and tax accounting (3) law Proven track record and experience
13
Business rescue key success factors (6)
BUSINESS RESCUE
Business rescue key success factors Business rescue key success factors
Business rescue scorecard The success rate of business rescue overseas is low There will, as done in 2004, be much hype from government and in the press, creating false expectations about the prospects for business rescue in SA We therefore call for a scorecard to measure and the track the success of all business rescue attempts under new legislation Number and turnover of businesses that survive business rescue Percentage of jobs retained as a result of business rescue Claimholder recovery rate as a result of business rescue Cost of business rescue Restructuring, turnaround or sale
14
Implications of new business rescue legislation
for private equity in South Africa
  • Business rescue
  • New business rescue legislation
  • Implications for distressed portfolio companies
  • Implications for distressed situation investment
    opportunities

15
The drafting of new business rescue legislation
in South Africa has had a rocky start, and is not
finalised
BUSINESS RESCUE LEGISLATION
  • 2004 The Department of Justice announced new
    business rescue legislation to replace judicial
    management which has been in existence since
    1926
  • Draft legislation prepared by Daly Inc. and the
    Banking Council of South Africa
  • Involved changes to existing insolvency
    legislation to be implemented within a year
  • 2004 The Department of Trade and Industry
    launched its own initiative
  • Business rescue legislation to be incorporated
    into the Unified Insolvency Bill of Professor
    David Burdette of the Centre for Advanced
    Corporate and Insolvency Law (CACIL)
  • Involved new insolvency legislation
  • 2005 After convergence between government
    departments, the dti announced new business
    rescue legislation as part of the new Companies
    Act (Chapter 6)
  • Oct 2005 Creditor-friendly proposal by Professor
    David Burdette based on the UNCITRAL Legislative
    Guide and aligned with SA insolvency legislation
  • June 2006 Latest version by new authors
    reportedly a debtor-friendly mix of judicial
    management, Chapter 11 and other compatible
    with SA insolvency legislation and Uncitral
    guidelines?

Next? What? When?
16
New business rescue legislation will provide more
protection and time for a troubled company to
rearrange its affairs and survive
BUSINESS RESCUE LEGISLATION
  • Could be debtor-friendly rather than
    creditor-friendly
  • Protection and more time
  • A moratorium on the rights of claimants and legal
    proceedings against the company
  • No interest, capital, creditor payments.
  • Moratorium will overcome two of the weaknesses of
    the informal creditor workout
  • It represents cram-down of dissenting minority
    creditors who cannot derail the process any more
  • Banks dont face the problem of free-riding other
    creditors any more
  • Ringfencing and ranking as to preference of
    creditors' interests
  • Post-commencement finance ranks highest (but in
    free-fall business rescue it is unlikely that
    there will be any unencumbered assets)
  • No time limit on the duration of business rescue
    as long as it is working
  • Opens the door for pre-packaged business rescue

17
Implications of new business rescue legislation
for private equity in South Africa
  • Business rescue
  • New business rescue legislation
  • Implications for distressed portfolio companies
  • Implications for distressed situation investment
    opportunities

18
Private equity firms will have more scope to
rescue their distressed investee companies, but
will lose control
IMPLICATIONS FOR DISTRESSED PORTFOLIO COMPANIES
  • Positive implications of new business rescue
    legislation
  • Will buy more time for restructuring, turnaround
    or sale
  • Through a moratorium on the rights of claimants
    and legal proceedings against the company
  • Could be debtor-friendly
  • Pre-packaged business rescue
  • before real financial distress has set in, will
    increase the chance of turnaround success, or a
    successful sale at value
  • Negative implications of new business rescue
    legislation
  • Loss of control to the 3rd party appointed to
    conduct business rescue
  • Challenge to private equity firms with troubled
    portfolio companies
  • Overcoming the stigma of bankruptcy

19
We expect workouts to be replaced by pre-packaged
business rescue to some extent
IMPLICATIONS FOR DISTRESSED PORTFOLIO COMPANIES
Example Turnaround under workout conditions
  • R400m T/O listed company
  • Z-Score graph reflects history up to 2002, and
    thereafter the turnaround plan inclusive of debt
    repayment schedule agreed with bank (informal
    creditor workout)
  • Share price was R0-35 in 2002
  • Company not insolvent
  • Turnaround plan attracted R20m private equity
    investment at R1-20/share (not reflected
    in Z-Score)
  • Share price increased to R2-00 within months
  • Company adhered to bank debt repayment schedule
  • 2006 forecast problems realised, share price
    dropped, bottom 5 of its sector on stock exchange

In this example the turnaround, although
successful, would have been easier and less risky
if it was conducted in terms of pre-packed
business rescue.
20
Implications of new business rescue legislation
for private equity in South Africa
  • Business rescue
  • New business rescue legislation
  • Implications for distressed portfolio companies
  • Implications for distressed situation investment
    opportunities

21
New business rescue legislation will stimulate
the market for distressed situation/turnaround
investment
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT
OPPORTUNITIES
Private equity financing stages
Opportunity in SA
22
In overseas markets within modern business rescue
jurisdictions, turnaround private equity lies in
the middle of the risk continuum
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT
OPPORTUNITIES
Private equity risk/return profiles
South Africa to move leftward towards the norm
New business rescue legislation will decrease the
current risk of turnaround private equity in
South Africa to be on par with the international
norm.
23
Private equity firms will have more time to
evaluate a larger number of deals, but the
competition will increase
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT
OPPORTUNITIES
  • Positive implications of new business rescue
    legislation
  • More time to conduct due diligences than before
  • Especially if pre-packaged
  • Less investment risk than before
  • Better due diligences
  • More stability before investing
  • All other things being equal, a higher number of
    salvageable distressed situations will be
    available to private equity firms
  • Negative implications of new business rescue
    legislation
  • More competitive deal flow situation for private
    equity firms
  • Higher prices more difficult to find bargains
  • because distressed businesses will have more
    time to find investors

What does the turnaround private equity market
look like at present?
24
The market for turnaround private equity has
substantially decreased over the past decade, but
there are signs of an impending upturn
IMPLICATIONS FOR DISTRESSED SITUATION INVESTMENT
OPPORTUNITIES
Compulsory company liquidations per month
The market for turnaround private equity is
expected to increase in 2007.
25
Questions ?
WRAP-UP
Turnaround Solutions is a turnaround management
firm advising and managing underperforming and
distressed businesses Corporate Renewal Solutions
is a business transformation and strategy-driven
management consulting firm TAS and CRS is a
division of Corprenewal, a black-owned management
consulting firm
Jan van der Walt
Turnaround Management Association Southern
Africa Tel. 011 964 2895 Fax 011 748 2809 Web
site www.tma-sa.com Email admin_at_tma-sa.com
Cell phone 082 853 1414
Land line 011 477 4414
Fax 086 510 6184
TAS web site TAS email www.turnaround-sa.com tas_at_turnaround-sa.com
CRS web site www.corprenewal.co.za
CRS email corp_at_corprenewal.co.za
26
Resume of Jan van der
Walt
  • As CEO of Corprenewal, Jan van der Walt has 26
    years' experience in turnaround management
  • In his career he served as both senior
    accountable executive, and in advisory positions
    in the public sector and in the private sector
    with clients as large as R5bn turnover
  • He has wide experience in devising and
    implementing leadership, strategy, financial,
    organisational and operational solutions in
    turnarounds
  • Jan is an active presenter at conferences,
    publisher of turnaround articles and web sites,
    and guest lecturing in turnaround management at
    business schools
  • In 2004 he initiated the Task Group for
    Organising the Turnaround and Business Rescue
    Industries, which included 100 representatives
    from various stakeholder groups in industry
  • The Task Group spawned
  • ABASA - Association of Business Administrators of
    South Africa - a proposed business rescue
    regulatory body in terms of future new business
    rescue legislation. Jan serves on the Interim
    Executive of ABASA as Treasurer.
  • Turnaround Management Association - Southern
    Africa, the establishment of which Jan initiated
    and concluded as a founder member.  Jan serves as
    Deputy CEO as well as on the International
    Committee of TMA International. 
  • Qualifications
  • MBA (Stanford Business School), where he studied
    with a Fulbright Scholarship and specialised in
    strategy
  • Honours B.Sc. in Operations Research (University
    of South Africa)
  • B.Sc. Industrial Engineering degree (cum laude)
    (University of Pretoria)
  • Personal web page www.turnaround-sa.com/team/jan
    van der walt.asp
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