Previously we have discussed the virtues of the Pre-Pack insolvency process, which ASIC prefers to call a company restructure. This month we will show that Pre-Packs are not always the answer and require careful management based on your client’s specific situation and business requirements.
Background
Very recently we assisted two clients whose company operated a public relations and marketing business. The directors were extremely good at marketing and PR, however, they did not have much interest in the administration side of running a business.
The company soon found itself in financial distress due as a result of a large ATO debt. The directors subsequently engaged a CFO. Further to these issues the company was also facing legal action which it could not recover from should it receive an adverse outcome.
Recommendation
As the company’s business was not only solid but growing exponentially, it was initially thought that a “Pre-Pack” arrangement could be implemented. You may recall from our previous month’s case a “Pre-Pack” essentially is a sale process where the assets and goodwill of the insolvent company are formally sold to a new company, usually with the same directors in control.
Normally, a goodwill valuation would include, to some extent, the value of the intellectual property (IP) of a business such as website, social media presence or phone numbers.
However, as the main asset of this company was its IP made up of copyright and designs, a normal goodwill valuation would not be sufficient. Due to the litigious nature of the partitioning creditor, we expected that the company’s IP value could be quite arbitrary. We were therefore mindful that if the directors subjectively determined the IP’s value it could be an issue.
Why?
If the sale of an asset is determined to be less than, the lesser of the market value of the property and the best price that was reasonably obtainable, it could be seen as a creditor-defeating disposition which could result in criminal as well as civil liability.
The difficulty with valuing IP is that there can be different guidelines that can have widely varying results.
Two approaches are typically used to value IP:
Income Method: IP valuation is based on future projected cash flows related to the IP.
Market Method: IP valuation is based on observations of actual third-party transactions of comparable intellectual property to determine a market price.
There is also a lesser-used method called the Cost Method. This method values the IP based on the cost of development of an identical or similar asset at a given point of time.
The trouble with different IP valuation methods is that it can lead to wildly different results. The company obtained multiple valuation reports which ranged between $1m and $6m.
This presented a dilemma. If the wrong value was chosen as the sale price, a liquidator could establish that, on the balance of probabilities, the price was less than the market value and best price reasonably obtainable for the assets at the time of the transaction.
Furthermore, a finding of illegal phoenix activity could result in the directors and their advisor being referred for criminal or civil prosecution.
“Licensing Pre-Pack”
With multiple valuations, there was a 4 to 1 chance that the wrong valuation would be chosen. It was agreed that the risk of proceeding with a Pre-Pack was too high. Selling the business and IP to a new company for what could be judged as less than market value could be problematic.
We therefore recommended what is one of the main elements in the Pre-Pack regime in the U.K. Rather than ‘sell’ the business, the company would ‘licence’ the business. In other words, it would have all the elements of a Pre-Pack bar one, being the ‘sale’ hence the term ‘Licencing Pre-Pack / Alternative Pre-Pack.
The company would become the licensor granting the right for the new company to use the licensor’s IP thus allowing for the new company to continue the business without missing a beat.
Upon the company’s insolvency, the new company was able to negotiate for the purchase of the IP from the insolvency practitioner. This eliminated any claim or action for illegal phoenixing as the insolvency practitioner not only consented to the sale but was a party to it.
Furthermore, it can often be the case where the negotiated price is at the lower end of the valuations.
Outcome
Using the chosen strategy not only rescued the business but allowed for its immediate continuity, a critical factor for customer retention. Another positive outcome was that the sale was private and not public knowledge. This meant the business kept its brand name and image in good standing.
de Jonge Read agrees with ASIC in considering this type of company restructuring process an essential rescue tool.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies. Contact us now on p. 1300 765 080 | ua.mo1729247150c.arj1729247150d@ofn1729247150i1729247150
Did you know?
Phoenixing is another name of business restructure. Read more about business restructures and when this can be an option for you.
