The challenges of managing insolvency in the IT sector
A company’s assets consist primarily of ideas, which can make the insolvency process a real challenge
If a company’s assets consist primarily of ideas, securing funding to keep the development of that idea going forward through an insolvency process can be a real challenge.
That’s because everything that is exciting about new technology becomes part of the problem when an IT company goes into receivership before its product has been fully developed. How do you value an asset that doesn’t exist yet, is highly sensitive to competition, international in scope, and has a high financial burn rate?
“It requires a great deal of confidence in the future product. You don’t see a lot of people rushing forward,” said Lance Williams of Cassels, Brock & Blackwell LLP at the CBA Insolvency Law Conference in Vancouver on Sept. 14. “The key question for financers is: how much do you want to spend, and is it worth spending it?”
The particular difficulties of managing insolvency in the IT sector was the topic of a panel discussion that included Williams, Kathryn Esaw (Stikeman Elliott LLP), Jeff Keeble (Deloitte Restructuring Inc.), and moderator Tevia Jeffries (Dentons Canada LLP).
Among those likely to be interested in such assets are industry competitors, which creates an instant conflict. How much of the company’s details should you reveal when you’re dealing with proprietary technology?
“The more due diligence you can show, the better value you’ll achieve,” noted Williams. “But too much due diligence and you have given the asset away.”
According to Keeble, the relationship with employees is also complex: “Developers are in demand, and to keep the new product alive, you need to retain the staff who can continue to work on it. You also want to be sure they aren’t going to leave and take proprietary information with them.”
This is one area where the different nature of the IT industry can be an advantage, however, even if payroll is significantly behind. “You have a lot of true believers prepared to go ahead knowing there will be a result later,” said Esaw. “That’s not something you see in other industries.”
There may be several international suppliers involved, at various levels of investment, whose products are critical to the future success of the new technology being developed. Getting a handle on those contracts and relationships early is key and, the panel advised, more than likely requires a business solution. Bringing important creditors up to speed quickly and keeping them in the loop throughout the process is crucial when you’re dealing with what Esaw described as a “borderless industry,” and one where licensing agreements can straddle several years.
Planning at the front end is even more important than usual, said Williams. “On day one you need to work out what you want to do, and how you’re going to handle the high burn rate while you do it. Pull together a full analysis of what’s there, what the aim is, and start flushing out the claims.”
IT insolvency may already be fraught with complications but Esaw warned there is an even bigger headache on the horizon: what happens when cryptocurrency companies start failing? Ownership of Bitcoin, for example, is essentially hidden to anyone not in possession of a key to the Blockchain network.
The ongoing controversy over the Mt. Gox insolvency case — which saw the Japanese Bitcoin exchange declare huge losses in 2014 in what has been described as the “cryptocurrency heist of the century” — highlights how difficult it is to navigate a business model that few fully understand and in which assets can be easily sequestered.
Eventually, vast amounts of the “lost” Bitcoin were found, but creditors were told their relationship with Mt. Gox was contractual, meaning they would only receive the value of Bitcoin at April 2014 rates, despite that value having skyrocketed since. Shareholders, meanwhile, stood to receive huge payouts. Earlier this year, that decision was reversed, and Mt. Gox was moved out of bankruptcy proceedings and into civil rehabilitation.
The central issue, however, remains. “If an insolvent debtor owns Bitcoin and they are not willing participants, how do you find their key and contain that asset?” asked Esaw. “How can you fully value their assets? How do you manage that?”
Beyond taking legal action to have them declared in contempt, Williams said, the options are limited.
“The takeaway,” he concluded, “is that current insolvency law is not up to date enough to deal with this.”