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Pre-Pack to the Rescue!


2024 is certainly proving to be a challenging year for Australian businesses. Therefore, understanding the available options is paramount.


This month, we will look at a client who was experiencing issues on a number of fronts.


Our client was an IT service provider to a large number of SMEs in Brisbane, Sydney and Melbourne. Turnover in 2022-23 was $3.5m.


Revenue was impacted by a large client's liquidation, resulting in a bad debt of just under $600,000, but more significantly, a loss of future sales. As a result, turnover fell dramatically by the end of 2023. To make matters worse, the liquidator was on the verge of commencing legal action against our client, claiming compensation for an alleged software upgrade that caused a breakdown of their IT system.


Our strategists met with the directors in early December 2023 when cash flow forecasts looked bleak. In addition, legacy debts had built up. The trade creditors were over $400,000, and the ATO was making threatening noises over $480,000 of long overdue tax debts, including $249,000 of PAYG liability.


In June 2023, the directors approached the ATO to improve cash flow, and a payment plan was agreed upon. This deal had been kept up to date until October 2023 despite payments being a huge $30,000 per month. Not surprisingly, the ATO also required the regular payments of PAYG and GST to be made on time.


The payment for November had been delayed, and the company had insufficient cash to pay the December payment.


A cash flow crisis was looming. The shareholders would not provide any further funds, and the directors were split as to the route to take next.


de Jonge Read’s standard approach for every client we meet is to discuss the options available, including the pros and cons, and then provide an obligation- and cost-free report on our recommended strategy. These included liquidation, voluntary administration, small business restructuring, and a pre-pack.


Liquidation: Liquidation was discounted as this would have seen a good business closed and many jobs lost.


Voluntary Administration: Voluntary Administration was a possible option, but not attractive because of the of the perceived bad press that comes with it.


Small Business Restructure:  The company did not meet the eligibility criteria as it had more than $ 1 million in total liabilities.


Pre-pack: This was, in our opinion, the best option. Basically, the assets and goodwill of the insolvent company are sold to a new company with the same directors and shareholders. The employees would be transferred to the new company, which would assume responsibility for their accrued entitlements. The amount equal to the assumed entitlements would be offset against the purchase price.


It is vitally important, when considering a pre-pack, that the new business model is financially viable. Once the new company is 'up and running' with the business, the 'old' company would be placed into liquidation.


It is crucial that the assets, including goodwill and IP, are sold for current market value. Anything less may be seen as a transfer designed to defeat creditors, which is classic illegal phoenixing.


Therefore, a proper valuation was required, preferably from a registered valuer. Being an IT business with much of its value based on intangibles (i.e., goodwill and IP), so valuations could vary dramatically. Therefore, prudence dictated that more than one valuation would be necessary.


With our help, the company obtained two valuations. The valuation methods used were similar, resulting in two recommended purchase prices with a difference of only $25,000. The recommendation was that the purchase price be the higher of the two. That choice would help prevent any claim that the price paid was less than either the market value or the best price reasonably attainable.


Ironically, the loss of a long-standing and highly profitable client that could not easily be replaced diminished the business's value, making it more affordable for the new company. Further, the shareholders who refused to invest more in the old company were quite willing to invest in the new company, which had no creditors or the risk of legal action.


The result was:

  1. the new company could continue with the business without pressure from the old company's creditors or the threat of litigation;

  2. directors remained in control of the business;

  3. goodwill was preserved;

  4. existing clients were retained; and

  5. employees kept their jobs.


If you have clients facing a similar situation, please call de Jonge Read for a cost and obligation-free consultation.

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