Viable or not? The question that precedes every restructuring process.

The turnover decreases, debts are piling up, a supplier is threatening legal action and the bank wants to talk. Whether you are an entrepreneur yourself or, you are a PE-investor that sees a portfolio company in trouble, these are the moments when the clock starts ticking.

Financial stress rarely strikes suddenly. The warning signs are there beforehand: having to choose between paying invoices, a growing tax debt, suppliers whose patience has run out, or a bank facility under pressure.

Bankruptcy is by no means always the only way out. When the business itself still has a future, but the debt burden stands in the way, debt restructuring can be a solution. The question at the heart of such a process is the subject of this blog: is the business actually viable after restructuring?

In this blog, we discuss two possible routes: the voluntary arrangement and the scheme of arrangement (WHOA). Both are aimed at rescuing a business with future prospects, without it being brought to an end by bankruptcy. But both only make sense if that one question can be answered in the affirmative.

What does viability mean?

Debt restructuring is a means of securing a company’s future. That is precisely why viability is at the heart of every restructuring process. If the company remains structurally loss-making even after restructuring, an arrangement with creditors solves nothing. 

But what exactly does viability mean? The answer is less straightforward than it seems. In the literature, viability is described as the ability to keep a business running in the future. This explicitly involves more than just financial performance: the quality of management, market position, capacity for innovation and the availability of sufficient market power also play a role. In short, a business is viable when it is able to meet all its obligations in the long term.

For entrepreneurs, this means they must carefully assess whether the company will be able to meet all its obligations again following restructuring. For (PE) investors, the same core question arises in a different form: does the problem lie primarily in past debt, or is the underlying business model insufficient? Only in the former case can debt restructuring actually preserve value.

Viability in a scheme of arrangement (WHOA)

The scheme of arrangement is intended for companies that foresee they will no longer be able to continue paying their debts, but where intervention is still possible before bankruptcy. The law does not set a formal viability test as an entry threshold. This is a deliberate choice: viability is difficult to establish conclusively at the start of a process.

Nevertheless, the concept is far from irrelevant. In the justification for the arrangement, it will be argued, on the basis of the forecasts drawn up, that a company is viable. If this is done in a well-reasoned manner, it will often be accepted. In this regard, the court will not immediately examine viability itself, but will only assess it if this is raised by one or more creditors. If it is evident that the company is not viable even after debt restructuring, a proposed arrangement will fail for this reason alone. The judge can and will therefore refuse the arrangement.

When proposing a arrangement, an explanation must be provided of what the arrangement means financially for creditors. Two values play an important role in this:

• The liquidation value: what will remain for creditors if the company is liquidated?
• The reorganisation value: what can be realised if the company continues as a going concern following the arrangement?

These values are not the same as the viability test, but they are closely related to it. If the reorganisation value is higher than the liquidation value, this shows that the arrangement can create added value compared to bankruptcy. This supports the idea that reorganisation is worthwhile. Ultimately, however, it must also be plausible that the company can actually continue after the arrangement. If that prospect is lacking, a scheme of arrangement has little to offer.

Viability in an voluntary arrangement with the Tax authorities

In the case of an voluntary arrangement between private creditors, there are no statutory rules. That changes as soon as the tax authorities is asked to cooperate in the remission of tax debts. Additional conditions then apply.

In short, the tax authorities will, in principle, only cooperate if:

• the amount offered is not less than what would be recoverable in bankruptcy;
• the tax authorities receives double the percentage of what is paid to other creditors;
• tax liabilities arising during the process are paid as normal; and
• there are realistic prospects of the business continuing after the arrangement.

This last condition constitutes the tax-related interpretation of the viability test. The tax authorities assesses whether the liquidity forecast shows that, following restructuring, the business will be able to pay all current operating costs, has sufficient scope for necessary replacement and growth investments, and can meet its new tax obligations in a timely manner. An arrangement that merely clears old debts but does not contain a sound liquidity basis for the future is insufficient. 

Viability can be demonstrated by an assessment drawn up by a bank, a chartered accountant (RA) or an auditor (AA). If no such statement is provided, the tax authorities will request a forecast of the balance sheet and profit and loss account, as well as a cash flow forecast for the two years following the conclusion of the arrangement, unless there are special circumstances. The tax authorities will then assess viability itself, based on the aforementioned documents.  

How do you assess viability in practice?

It is not always immediately clear whether the business is viable after debt restructuring. The following questions help to clarify this:

1. Is the business operationally profitable, regardless of its debt burden? If the core business is loss-making, debt restructuring may improve the balance sheet, but it does not solve the actual problem. 

2. Does a conservative liquidity forecast hold up? Anyone can make optimistic forecasts. When drawing up forecasts, be sure to take setbacks into account as well, so that it becomes clear whether the business is truly future-proof. 

3. Which debts need to be restructured to make the company financially viable again? These include bank loans, tax debts, rent arrears, trade payables and any shareholder loans. An arrangement that does not remove all obstacles is not a solution.

4. Is new capital required, and who will provide it? Restructuring eliminates historical debts, but if there is also an operational liquidity shortfall for the coming period, additional interim financing will be needed. Who provides that capital, under what conditions, and whether this is realistic, will help determine whether the restructuring plan is viable.

5. Is there support from key stakeholders? A business may appear financially viable on paper, but could still run into difficulties in practice if the bank, tax authorities, landlord or a strategic supplier refuses to cooperate.

When is an arrangement pointless?

An arrangement is not a universal solution. There are situations in which embarking on such a process will not achieve the desired outcome:

• The company remains structurally loss-making even after restructuring, because the business model no longer works.
• The liquidity forecast only holds up under highly optimistic assumptions regarding turnover, margins or cost savings.
• The necessary additional financing is not available.
• New obligations cannot be met in time during the process, meaning that creditors, such as the tax authorities, are unable or unwilling to cooperate.
• The arrangement clears historical debts, but the operational problems remain.

In such cases, an arrangement, even if successful, will at best provide only temporary relief. It may then be wiser to opt for a controlled sale, a partial liquidation or to file for voluntary bankruptcy, rather than investing time, money and energy in a process that ultimately yields nothing. 

Conclusion: start with the question, not the tool

An arrangement can be a powerful tool for rescuing a business. But the instrument is not the starting point. That is the question of whether, after restructuring, a business remains that can operate independently.

Is the business fundamentally sound, but there is an excessive debt burden? In that case, an voluntary arrangement or a scheme of arrangement can provide the space needed to recover. If the problem is more structural, then another question deserves priority: should the business be downsized, sold or wound up?

For the entrepreneur themselves, the question is whether, after restructuring, there is still a business worth continuing. For the investor, the question is whether the residual value and the prospects justify the injection of additional capital.

No one can say with certainty what the future holds at the start of a restructuring process. But that does not make the question any less urgent. On the contrary: because the answer is never entirely certain, it is all the more important to ask it before taking any major steps.

Those who skip that question are buying time. Those who ask it are buying the future. Whether you are the business-owner yourself or you are the investor: the value of an arrangement stands or falls on what remains afterwards.