No Access to Alternate Finance and Inability to attract Equity Funds
Insolvency is determined on a cashflow basis reflecting the definitions contained in the Corporations Act. The basic premise is that an entity is insolvent if it cannot pay its debts as they fall due.
Two debt restructuring alternatives are open to entities with insufficient cash to meet their claims as they become due and payable:
The debtor can convert short-term debt into longer-term debt. This is dependent on the agreement of creditors. Simply because a creditor does not pursue debt does not mean that it has been converted.
The debtor can seek to obtain funds from equity capital. Equity capital is, by definition, not a debt. On the other hand, potential equity investors, knowing that an eventual return may be delayed or uncertain, are likely to be diligent in reviewing the finances and prospects of the venture in an effort to be satisfied that a return is commensurate with the risk.
If a business is unable to convert short-term debt to long-term debt to overcome cash crises, or is unable to replace debt with equity to cure the lack of funds, these factors must be strong indicators that the business is insolvent rather than simply suffering from short-term cashflow problems.
