The 2019 Financial Reporting season has thrown up examples of very specific disclosure of the conditions imposed on listed borrowers by their lenders.
Case 1 – The amount and timing of an equity raise.
Case 2 – A requirement to conduct a ‘strategic review’ of ‘funding options.’
Case 3 – The timing and requirement for an equity raise to meet a balance sheet ratio.
Such disclosure is a two-edged sword.
Certainly, potential purchasers of the shares will be very well informed – but at the same time, the disclosure is likely to make it harder for management to achieve a turnaround. Perceived financial fragility may lead key staff to look elsewhere, and will probably make it harder for the businesses to win new business. In some cases, it will also create liquidity problems if suppliers decide to reduce trade credit limits.*
Why is such disclosure required?
Listed companies have multiple disclosure requirements. The Listing Rules impose a continuous disclosure regime, with limited exemptions – for example where negotiations are underway, or are confidential to another party. The Accounting Standards also impose further disclosure requirements.
If disclosure was made to comply with the continuous disclosure regime then arguably it should have been made earlier – when the companies received notice of their lender’s requirements.
Disclosure in the Annual Report suggests that the disclosure was prompted by the auditor’s review of the financial statements – but for an outsider it is difficult to say whether it reflects a belated ‘catch up’ of continuous disclosure, or whether it is intended to ensure compliance with Accounting Standards.
Theoretical arguments about the reasons for the disclosure and whether it is strictly required may not be much help up for companies up against a deadline. Two of the case studies had audit reports signed on the latest possible date – perhaps they simply ran out of time?
How should directors mitigate harmful disclosure?
Of course it is important that directors ensure that investors are adequately informed – but they should try to avoid do so in a way that makes it harder for the business to achieve a turnaround.
Harmful disclosure can be mitigated – but it becomes so much harder after balance date.
Businesses in turnaround mode should be projecting their compliance with covenants as part of their normal board reporting. If non-compliance seems likely, then it is important to negotiate with lenders well ahead of any deadline. Of course, those negotiations are far easier if supported by a well thought-out and comprehensive turnaround plan that will provide comfort that any underlying issues have been identified, and will be addressed.
* That’s also the reason why I won’t identify the companies here.