Evans & Tate Limited is an Australian company listed in the Australian stock exchange with her headquarters in Wimbley, Western Australia. The core business of the company is production, distribution, and marketing. They produce branded and unbranded wines, for normal business, contractual purposes, and wine tourism using satellite stores. The company had a sound financial position and was posed to a world-class producer of wine until they borrowed heavily from creditors.
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The directors ignored a stable capital structure and took aggressive policy in managing finances until the company was caught in financial distress. They were unable to meet short-term and long-term obligations.
In the year 2004-2005, they reported a loss of AU $ 71,568,000 which was higher lower than the previous year. In this year the current ratio was less than one meaning the current assets if liquidated can not be able to offset current liabilities. This meant the short-term liabilities like interest and fallen due to principal amount for debt holders were going to technically default. in the year 20005-2007, the reported a reduction of the loss by 12%. It reduced from Au $ 71,568,000 TO 63,900,000.the accumulation of such losses also leads the company to a financial crisis. During the same period, the balance sheet of the company revealed that the liquidity was in question as AU’s $90,930,000 current assets were available to pay an equivalent of AU’s $152,377,000,000 l current obligations which had come due within the next 12 months. The further scrutinize of the balance sheet for the period revealed that total liabilities of AU$207,445,000,000 exceeded total assets of AU$139,792,000,000.this meant that in case of liquidation the shareholders will be called to contribute AU$67,653,000,000.
After realizing such a financial position entered into a series of agreement with various stakeholders to it from the financial quagmire. The company, Evans & Tate Limited agreed with her bankers, Australia and New Zealand Bank, and Pendulum Capital Pty Limited for a formula in restructure. The structure plan was that Australia and New Zealand Bank and Pendulum Capital Pty would partner in representing the investor’s community. The structure was to be realized through the issue of new shares in the form of rights issues. The funds that were to be generated were meant for working capital that is improving the current assets to meet the current obligation, capital investments, and strategic acquisitions to improve future profits.
Costs associated with defaulting to pay debts
Defaulting to pay debts by a company has many costs (argues David, 2004). the costs associated with defaulting to pay will affect the management, employees, shareholders, debt holders, and other stakeholders. The management will be the most affected as their jobs will be in question, litigation will follow from debt holders, and Company will get bad publicity about creditworthiness and there will be the cost of sweeteners.
When a company technically fails to pay its obligations as agreed the bondholders would look for ways to recover their principal and the fallen due interest. this demand from bondholders could trigger litigation. Litigation will disrupt the company’s operations and create unnecessarily. Should the bondholders take that route in the recovery of their debt then the company may be liquidated if the proper agreement is not reached. The other cost associated with technical default to the managers is bad publicity. When the company fails to pay her debts, her creditworthiness becomes in question. An instance where the creditors’ meeting is called means that the company is on the verge of collapsing and the only out is to liquidate. In recent times some investors have found a way of profiting from technical default through sweeteners. Sweeteners may include backdating of stock options, adjusting their earnings but all these additional expenses to the company. This form of concessions to bondholders to avoid default is an expense that may in the long run lead to bankruptcy of the company.
Managers will lose their jobs in case the company fails to meet their current and long-term obligations (Benfari, 2000). Take the example of Franklin Tate he resigned after the company performed poorly paving way for somebody who will put the company on track. If the default is a result of fraud within the company then managers may face criminal charges in a court of law. This has been witnessed in the case of the Enron of USA. The top managers are now facing jail terms for wrongs committed to the company.
Shareholders will incur a lot of costs in case the company fails to honor its obligation. Failure to honor will lead to bankruptcy and bad publicity. Because of these, the shareholders will lose their investments through the undervaluation of their shares. If we look at the case of Evans and Tate, the value has become too low the level that they are described as worthless. When a company is facing such a situation of default the shareholders do not get returns for their investments. The returns to shareholders are in form of dividends. Dividends depend on the profitability of the company, when a company is making losses then there are no returns.
Debt holders have the interest to lose in case of technical default. There is also loose of investment in cases such as Evans and Tate wine company. New arrangements may be sort whether favorable or not since they may little choice. This disrupts their stream of income thus affecting their plans. Other costs of litigation will come into the scenery in case the company fails to come up with an acceptable formula on how to settle the debt.
Innocent family men will lose a source of income through retrenchment, salary adjustments, and loss of benefits in case the company goes under.
Strategies to assist in avoiding technical default
Many strategies can be used to avoid a technical default. Among the strategies adopted by companies include valuation of assets, rights issue, and conversion of debt to share capital, issue of sweeteners to bondholders, restructuring, and borrowing. Valuation of assets provides profits that will be used to offset the losses incurred during normal operation. The valued assets may be sold to raise funds for working capital management. In case there no sale of assets the company uses a strong financial position to obtain credit for a stable working capital.
Conversion is a very important strategy in avoiding technical default. Conversion involves the converting of debentures into share capital. This may be done when the company realizes that its financial position is not good and they may face the problem of meeting both short-term and long-term obligations. This may happen through negations with the debt holders even if there was the option of such kind of arrangement during the issue of the t bond. If the was such terms and the period has not been reached then negotiation to bring the conversion to an earlier date is necessary. There are many advantages of conversions.
Rights issue – is an offer to the existing shareholders to subscribe for fore shares in proportion to their existing shareholding. It is a limited source of finance. An ordinary resolution must be passed allowing the offer with the blessing of the stock exchange
Characteristics of Equity financing
Usually, have voting rights in general meetings of the company. Rank after all creditors and preference shares in liquidation. Dividends are payable at the discretion of the directors out of undistributed profits after senior claims have been made.
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Advantages of Equity financing
No provisions are made for repayment of dividends as they are only paid if profits are available. Not limited – depending on the size of the investment, the company can quote as many shares as it likes.
Expensive – there are many cost reasons required to raise these finances for example advertisement. Dilution of control as most of the shareholders have voting rights in the control of the company. Not tax-deductible since retained earnings are taxable. Not liable since not all companies can access this form of financing. Risky – as large amounts of equity finance may increase the rate of return and reduce the earnings per share.
They may issue new debt to offset the old debt. This strategy is however very dangerous for a company in a financial crisis. But if it reduces the obligation and postpones possible litigation, it works. Debentures are sources of financing whereby funds obtained can be repaid after along period normally from eight years and above. The company pays interest and principal or dividend at the stated or prescribed period. They are written acknowledge of a debt by a company containing provisions of interest and the terms of repayment of principal. This can be secured or unsecured or irredeemable or redeemable. Secured debt will carry charge on one or more specific assets or all assets of the company such that on default of repayment of interested principal, the debenture holder will appoint receive to administer the assets until the interest is paid eventually they can sale the asset to repay the principal. Redeemable debt is where the principal is repayable at a specified future date whereas irredeemable is the opposite. This form of strategy to financial obligations to avoid default should be analyzed carefully before adopting.
The last strategy available is the issue of sweeteners and backdating of obligation. This will assist in avoiding possible litigation and eventual bankruptcy. To avoid default, companies have offered concessions to bondholders in the form of extra fees or better terms on the bonds to act as sweeteners.
This is costly to the company in the long run. They may include some options which may dilute the company shareholder
Strategies used by Evans and Tate in avoiding technical default
There are many ways of avoiding technical default.in the case of Evans and Tate used negotiations with bankers and other creditors for financial restructuring.
The negotiation saved the company from collapse and similar arrangements have been made in the past by many companies. The troubled company reported the following
“Under the Restructure Plan and following the placement to Australian and New Zealand bank, Evans and Tate Wine will undertake a non-renounceable rights issue, fully underwritten by ANZ and Pendulum, to raise approximately AU$16.7 million at 5 cents per share. The issue will be on a 1 for 2 bases to all shareholders, comprising the restructured equity base of ETW. Shareholders who take up their entitlement will receive one free option for every two shares subscribed for. The options will have a five-year term and be exercisable at any time at 7.5 cents.
Under the Restructure Plan, relevant ETW security holders will be invited to meet and asked to approve (in their relevant classes):
- the issue of 429,645,454 ETW shares in exchange for ANZ forgiving AU$45 million in principal debt. ANZ will sell half of these shares to the Pendulum Investor Group for an undisclosed sum;
- the conversion of the convertible notes into ordinary shares at a conversion ratio of 4.18 ordinary shares for each note; and
- the conversion of Wines into ordinary shares at a ratio of 2 ordinary shares for each wine.
The effect of the agreement (if completed) will be to reduce ETW’s existing debt to ANZ to approximately AU$55 million.
The proceeds of the rights issue will be used primarily for working capital, capital works, and possibly other strategic acquisitions. Given that the proceeds of the rights issue will be used in part for working capital purposes, ETW will no longer require AU$5 million working capital facility from ANZ. This means that the ongoing facilities will be approximately AU$55 million rather than the AU$60 million previously announced.
The in-principle agreement is subject to the completion of satisfactory due diligence by ANZ and Pendulum and is not legally binding on all parties until formal documentation is executed. The Board of ETW will continue to examine all alternate offers for the restructuring of the company”. Quoted, from Troubled Company Reporter, June 19, 2007.
The other strategy of financial restructuring used is the sale of assets to finance operations. The company sold one of her branches as part of the strategy to avert a possible collapse.
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