Picture: THE HERALD/MIKE HOLMES
Picture: THE HERALD/MIKE HOLMES

The SA economy has been underperforming and failing to sustain substantive economic growth for the past few years; in fact, it has contracted at times.

Unfortunately, in light of the global Covid-19 pandemic the country’s economic prospects are going to get worse before they get better. The economy is  expected to shrink by a further 5% or more this year. From this it is projected that as many as 1,600 businesses will be declared insolvent and that 7-million people could lose their jobs.

Steady economic decline seems unavoidable, but with a strategic pairing of business rescue and private equity the damage can be limited, and there could even be a pivotal shift in the economy’s trajectory.

Business rescue is a strategic tool provided for in the Companies Act, which is designed to rehabilitate businesses that are financially distressed. The act provides for one of two scenarios for a company to be qualified as financially distressed for the purpose of business rescue. The first is when it is reasonably unlikely that it will be able to pay all of its debts as they fall due within the next six months, and the second when it is reasonably likely that the company will become insolvent within the next six months.

Business rescue is designed to alleviate the financial pressure on the business so that it has an opportunity to recover and return to profitability. The way in which the business rescue process does this is by creating an environment that allows a business rescue plan, compiled by a professional business rescue practitioner, to be successfully implemented to avoid the need for the business to be liquidated. This environment is created in part by placing a moratorium on claims against the business.

This gives the business an undisturbed period to focus on the implementation and execution of a suitable rescue plan. The function of the plan is to be an effective blueprint that demonstrates how the business can and will recover from its position of financial distress. It is also a persuasive voice in securing court approval and consent from creditors, which are required for business rescue proceedings to commence.

The business rescue plan is also an effective instrument in securing post-commencement finance. This is the second fundamental component of business rescue proceedings, the credit or finance offered to a business undergoing business rescue proceedings to fund the implementation and execution of the business rescue plan.

The traditional source of post-commencement finance is the banks, and in a bullish economy this would be the first port of call for most businesses. However, in the context of a pending local and global economic recession this may become a constrained source of finance. Many financial sectors will be put under pressure during an economic downturn.

However, other sectors, such as private equity, thrive in bearish economies. Private equity is a source of alternative finance that can be defined as unlisted capital that is invested into private or public companies. It is categorised as alternative finance because it falls outside the traditional scope of finance, which includes debt and listed equity. The way in which private equity operates is to have a collective group of investors who provide a pool of money that is used to invest in assets that are in line with that private equity fund’s investment strategy.

In the SA context private equity finance distinguishes itself from sources of traditional finance in a number of ways, such as operating in an unregulated market. Private equity transactions are executed by funds, which are set up through the establishment of partnerships. The partnerships that form the private equity fund that invests in different assets are not regulated by statute, unlike other traditional financial institutions. The utilisation of partnership structures to establish private equity funds has the added benefit of creating a tax transparent structure, which may be effective in mitigating investing cost.

In this economic environment what gives private equity finance the upper hand over traditional sources of finance is its resilience in bearish markets. Private equity markets have consistently, locally and globally, outperformed public markets. These features collectively demonstrate the compatibility between private equity and business rescue. They also augment each other in that they offer remedies for the other mechanism’s limitations. For example, where business rescue is compromised by a lack of post-commencement financing, this problem can be remedied by private equity finance. Another example would be where private equity is prone to high regulatory risk, and the regulatory framework provided by business rescue can mitigate the regulatory risks in private equity.

The complementary pairing of private equity and business rescue is now heightened in the economic environment. A strategic deployment of this powerful combination can be a useful mechanism to repair the SA economy and mitigate any further economic and social consequences flowing from the Covid-19 pandemic and economic lockdowns.

• Gwata is founder of Kukura Capital.

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