The ‘crafty’ use of business rescue mechanisms and financial support from private equity funds may play a fundamental role in the economic rehabilitation of South Africa as an emerging market

5th April 2017

The ‘crafty’ use of business rescue mechanisms and financial support from private equity funds may play a fundamental role in the economic rehabilitation of South Africa as an emerging market

The introduction of the business rescue provisions as part of the new Companies Act in South Africa has contributed to a fair degree of economic growth and sustainability in the country’s expanding sector of distressed companies. The fact that data provided by the Companies and Intellectual Properties Commission reveals that more than 850 businesses from a wide range of industries including textiles, mining and retail have been placed into business rescue since May 2011 is indicative of the crucial role that business rescue has played in South Africa’s economy thus far.

In a similar way to Chapter 11 Rules in the US, struggling firms are now given the opportunity to try and work together with various stakeholders in an attempt to rescue the business rather than simply file for liquidation and ‘close shop.’ As a result, there are now more businesses seeking private capital to help them improve their balance sheets and restructure. This has created a growing interest in distressed debt opportunities in South Africa, and a select group of private equity funds through which investors can take advantage of these opportunities are beginning to emerge. Given the continuation of the country’s economic woes and weakening rand, the business rescue mechanisms in the new Companies Act and distressed debt investment from such private equity funds may play a fundamental role in the economic rehabilitation of South Africa as an emerging market.

Chapter 6 of the new Companies Act incorporates the business rescue legislation and provides a pragmatic, robust and effective mechanism which is similar to procedures available in other international jurisdictions such as the UK, Australia and the USA. Dr Eric Levenstein has highlighted that the business rescue legislation offers a “fairly creative mechanism and if approached in a manner which allows for the beneficial outcome for all stakeholders, can result in good value assets being acquired through the process.”

The process includes the appointment of a business rescue practitioner whose role is to supervise the commercial affairs of a distressed company on a temporary basis while the company is being restructured or potentially sold to a third party. A business rescue practitioner is only appointed if there is a realistic prospect that the company can be rescued, otherwise the company is placed into liquidation. A moratorium on all claims exists for the duration of the rescue period meaning that no creditor can enforce claims against the company, attach its assets or apply to court to liquidate the company whilst the company remains in business rescue.

Once appointed, the business rescue practitioner engages with all stakeholders in the business and labour sector in an effort to compile an effective and realistic business rescue plan aimed at rescuing the company. Debt due to creditors is restructured and most creditors are asked to agree to a compromise of their claims.

Once a plan has been voted in by all creditors involved, the company can exit the rescue process. This may result in the company continuing to trade on a solvent basis. Alternatively, the plan may allow for the company’s business/assets or shares to be sold to a new owner. In either way, if a plan is accepted creditors are most likely to end up receiving a better dividend in business rescue then they would receive in liquidation.

A private equity firm is an investment management company that provides financial support and makes investments in the private equity of start - up or operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth capital. Often described as a financial sponsor, a private equity firm will raise funds that will be invested in accordance with one or more specific investment strategies. Typically, a private equity firm will raise pools of capital, or private equity funds that supply the equity contributions for these transactions. Private equity firms, with their investors, acquire a controlling or substantial minority position in a company and then look to maximise the value of that investment.

Many distressed companies have ended up being acquired by third party investors such as private equity, hedge fund and venture capital firms where either the shares or the business/assets of these companies have been acquired at substantial discounts. Levenstein states that South Africa is now regarded as a new “unsaturated” market for distressed asset investment, with private equity firms entering the market and providing post – commencement funding and funding for acquisition purposes. Post – commencement funding is vitally important for the success of any business rescue process. This is because such funding helps to ensure that a company which is being restructured or is being acquired by a third party acquirer is able to pay its ongoing expenses during the business rescue process thus allowing the company to survive and ultimately escape liquidation.

Levenstein further states that the key to the success of such intervention from private equity firms is to “identify the distressed company as early as possible in order to retain value and to ensure that the company is ripe for acquisition.” If a private equity firm enters the market too late, it risks acquiring the company at a stage where much of its value has already been destroyed and the value of the business/asset has diminished.

Erika Van der Merwe, CEO of the South African Venture Capital and Private Equity Association (SAVCA) is of the firm belief that distressed assets are very compatible with the private equity model, which she describes as “hands on.” However, she warns that a very specific skill set is required to tackle distressed assets successfully and it is a very risky business if you don’t have these skills and the experience to identify the opportunity and then make it work. Levenstein shares this opinion, and further states that the right advisors and practitioners are vital to identifying the difference between companies that can be saved and those that can’t.

Africa Special Opportunities Capital (Asoc) Fund 1, a new type of private equity fund for South Africa with a focus on injecting money into distressed companies so as to rehabilitate them, was introduced towards the end of last year. Asoc Fund 1 has already raised R150 000 000 (one hundred and fifty million rand) mainly from Conduit Capital, MMI Group and its founding partners and expects to complete its first transaction during the course of this year with the hope of completing a second one. Asoc Fund 1 will invest between R30 000 000 (thirty million rand) and R50 000 000 (fifty million rand) in a company that is fundamentally sound but may have hit a financial obstacle, for example the loss of a major customer.

Shaun Collyer, chief investment officer of Asoc Fund 1, has stated that ideally the fund managers prefer finding a solution before a company opts for business rescue, but it is also prepared to provide post – commencement finance with the agreement of the business rescue practitioners. The fund will extend collateralised debt, which it could convert into equity after a company emerges from business rescue. Collyer has further stated that Asoc’s primary mandate will be to rescue and restructure businesses and save jobs, not strip assets. The cost of Asoc’s funding will vary depending on the risk and the security available in each situation, but in all cases will be structured to support the business and avoid another crisis.

Asoc Fund 1 is a pilot fund to test the concept in South Africa and, if successful, will be followed by others. Given the current financial downturn across the world and the growing number of distressed companies in South Africa as a consequence of this, the success of funds such as Asoc Fund 1 will be a boost for the economic rehabilitation of South Africa as an emerging market.

Written by Nandile Ndiviwe Tabata, Candidate Attorney (Litigation), Knowles Hussain Lindsay