The COVID-19 pandemic is having deep effects on our economy. Nearly all businesses have been affected in one way or another. Unfortunately, this may lead to a financial crisis, where a business finds itself unable to meet all obligations to its creditors.
Depending on individual circumstances, renegotiating obligations using the principles of insolvency can allow businesses to continue operations without actually becoming insolvent or applying for bankruptcy.
Here's how the process works.
First, determine if you are cash flow insolvent, balance sheet insolvent, or both.
Cash flow insolvency is a situation where a business has insufficient amounts of cash inflows to meet its cash outflow requirements, such as short-term debt obligations.
Balance sheet insolvency is a situation where a business's liabilities exceed assets on its balance sheet. Essentially, the business has a negative net worth.
If your business is cash flow insolvent, the next step is to determine what type of creditors you have. The three main types of creditors are:
Secured creditors are lenders where the debt issued is backed by an asset as collateral. In an insolvency, secured creditors receive priority when claiming any payouts since the loan is secured with the collateral.
Preferential creditors generally include employees who are owed wages or revenue authorities such as governments collecting taxes.
Ordinary unsecured creditors are lenders where the debt issued is not backed by any collateral.
Once the types of insolvency and creditors are determined, the next step is to develop a debt management plan.
A debt management plan involves consolidating debts. It may include a Corporate Voluntary Arrangement (CVA). A CVA allows a business to lower its debt payments by changing the terms of a loan. This might include paying a smaller portion of the original amount, or increasing the duration of the loan.
For example, if a business is struggling to make substantial monthly loan payments, a CVA might allow the business to convert it into a longer term loan with very small, manageable monthly payments. By renegotiating the terms of the loan, the business is able to continue operating in a situation where it otherwise may have been forced to declare insolvency.
Businesses don't have the face the challenges of COVID-19 alone. Fernandez Young LLP has a team of consulting specialists that help businesses of all sizes with financing and debt-related challenges. Contact us here.