In our first article in this series, we looked at the mystery of why apparently solvent companies end up heavily devalued and paying almost nothing to their unsecured creditors if they have the misfortune to file for insolvency. Now we dive into more detail into the conflict between book values and real life realisations in an insolvency context, starting with a Cooks Tour of what should be the most solid and reliable of all balance sheet categories: non-current assets, or fixed assets as they used to be called.
Intangible assets
These items arise in all sorts of ways, of which the most common is the Goodwill created when business assets are bought for more than their accounting values, usually reflecting either the over-exuberance of the purchaser or the implied benefit of the right to use the assets to generate future profits.
Equally nebulous, but occasionally more easy to sell, is Brand value, which is associated with the uniqueness of a business, its reputation and the ability to exploit this to earn profits. A less kind assessment might be that this represents brand development and marketing expenditure not written off immediately against profits but instead phased over time.
Capitalised R&D occurs in many sectors, notably in manufacturing, and the pharmaceutical industry where writing off research expenditure in a single (or few years) on products with a life span of twenty years would clearly be inappropriate. Similar considerations apply to IT Software.
The list of intangible assets is endless, but they all share one drawback in a forced sale, insolvency scenario. Unless the potential buyer will be continuing the business, they are worth little or nothing. Even then, without some element of competition between a number of bidders, the price paid is likely to be disappointing. This is due to the potential high cost and relative uncertainty of successfully transferring them into, and exploiting them under, new ownership, as well as the possible tainting of them through association with an insolvency.
Property, plant & equipment
Here at least there is some hope of independent markets for the items and competition between willing buyers to preserve realisable values. Or is there? Property used for commercial purposes can be impacted adversely by many factors. What condition is it in? Are there potential environmental liabilities? What are the options for and costs of re-purposing for alternative use if the business is not being sold on as a going concern? Is the location right for the likely buyers? Are there more modern and cheaper premises nearby? What about energy efficiency? If the tenure is leasehold, are the terms onerous?
Plant and equipment is the catch-all description for everything from blast furnaces and other technical equipment, through advanced robotics to computers, office furniture and company vehicle fleets. The latter will almost certainly be subject to finance obligations that will eliminate any realisable value. The others will most probably be too specific to the business to be of any significant value except where the business is to be continued by the new owner, for example the fixtures and fittings in retail premises or a hospitality site. There are exceptions, but these assets will not be a pot of gold and only rarely are they sold for anything like their book value.
Investments
These could be listed securities, shares in private companies (including associated or fellow subsidiary entities) or perhaps participation rights in joint ventures. Listed shares have by far the most identifiable and achievable values, although if they are significant but minority stakes they may not easily be sold at market value. Private company investments can be time-consuming and cumbersome to sell. The recent experience of multi-national groups trying to divest shares in joint ventures or activities in Russia after the start of the Ukraine conflict is an object lesson in rapidly evaporating value.
You may also be interested in: Why does insolvency reduce business value?
Other non-current assets
These days, all sorts of theoretical values turn up under this heading. It could be the surplus in a pension scheme, or the potential upsides in financial derivatives or hedging arrangements. Will they generate cash once a company has filed for insolvency? They might, or then again, they might not.
Location, location, location
Another major consideration in judging what non-current assets might fetch is where they are located, either in physical terms or as regards their domicile for legal or tax purposes. Not only can the costs and practical difficulties in selling such items be different around the world than in the UK, but a declaration of insolvency can change ownership rights or trigger disposal restrictions and potential tax obligations in some overseas jurisdictions.
Realisation costs
Old-fashioned accounting terminology used to talk of assets being stated at the lower of cost and net realisable value, implying that disposal costs had been taken into consideration where appropriate. In a formal insolvency, these costs will inevitably be higher than for a going concern sale, and in some circumstances can be higher than the actual value, thereby precluding any sale.
Are these assets subject to security in favour of lenders?
Aside from leased assets which are subject to specific control by their legal owners, non-current assets and in particular property and investments will often be subject to fixed charges in favour of the company’s lender, imposing possible constraints on their sale.
Is this really all about going concern vs. break up sales?
Usually, the answer is a simple ‘yes’. These assets are inevitably worth more if they are to be used in the same business under new ownership, which is why the best course when a business is encountering financial difficulties is to seek professional advice as soon as possible. The longer the delay, the fewer and less beneficial the options there will be, especially if a formal insolvency process becomes necessary.
If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.