Tackling the turnaround tsunami The UK economy is bracing itself for yet another quarter of poor economic performance as disastrous financial data and doom laden predictions keep arriving in inboxes and across desks. The effect of the severe economic retraction is beginning to be felt right across UK plc as finance houses and insurers continue to retrench their positions and revenues fall for retailers, manufacturers and service businesses alike.
In association with:
Bruce Mackay Partner Baker Tilly Restructuring and Recovery LLP +44 (0) 20 7002 8600 firstname.lastname@example.org Dr Jose Guzman-Bello Managing Director Consult Avila Ltd +44 (0) 7810 512742 email@example.com Simon Freakley CEO Zolfo Cooper Europe +44 (0)20 7332 5000 firstname.lastname@example.org Alain LE BERRE Managing Director Huron Consulting Group +44 (0) 208 895 4692 email@example.com Alyson Howard Director Meta Corporate Finance +44 (0) 189 282 0602 Alyson@metacf.co.uk Peter Kubik Partner UHY Hacker Young firstname.lastname@example.org David Hudson Director Begbies Traynor +44 (0) 207 398 3791 David-Hudson@begbies-traynor.com
The combined effect of a fall in revenues and a reduction in funding has led many, previously healthy businesses, to the precipice of insolvency. These distressed businesses face the stark choice of allowing the company to fail or to cede control to a turnaround professional, to turn the entire business around or restructure the operations within it. A recent survey of turnaround professionals from PricewaterhouseCoopers, completed in February this year, found a fairly pessimistic attitude to the immediate future of the UK economy. Almost 73% of those polled claimed it is now significantly harder to turn around failing companies than when previously polled at the end of September 2008 just after the collapse of Lehman Brothers. Two thirds of those surveyed suggest companies will be forced to undergo a level of job shedding, while 28% of respondents said their clients had breached banking covenants. Significantly more than 60% of experts suggested management teams were reluctant to employ turnaround expertise and some alluded to executives exhibiting a â€œhead in the sand mentality.â€? This statistic is particularly compelling when considered in conjunction with Q4 statistics from the Insolvency Service which show that there were 4,607 compulsory liquidations and creditorsâ€™ voluntary liquidations in England and Wales in the fourth quarter of 2008. This is an increase of 11.9% on the previous quarter and an increase of 51.6% on the same period a year ago.
The importance of professional advice in a changing economic environment The conclusion to draw from this data must be that corporate executives need to grasp the nettle and attempt to turn around, or restructure, a company at the earliest stage possible, if they wish to prevent their business failing. Alain Le Berre, managing director of Huron Consulting Group, believes the economic crisis is now strengthening its grip across many sectors and geographies, and more people are coming to realise that the banking and financial mess April 2009 Corporate UK 13
Many of the corporate failures we have seen to date have been what could be classified as poor businesses which survived longer than they possibly deserved to owing to easy access to funding which effectively papered over the cracks.
has not been completely exposed yet. He suggests there is an onus on creditors to push for restructure at an early stage. He said: “Clearly, it will get worse still before it can start to get any better. There is a tendency towards fewer traditional work-out restructurings, and more administrations and pre-packs. The reasons are mostly lack of available liquidity, or in some cases that the decline in revenues is simply too brutal and too deep (as in some automotive cases for instance). This may be a worrying trend as unsecured creditors who don’t push for a consensual restructuring process early on may end up being completely disenfranchised in a pre-pack.” Bruce Mackay, partner at Baker Tilly Restructuring and Recovery, says that, despite the gloomy conditions, there is still a steady flow of restructuring cases where an outcome other than formal insolvency prevails; the keys are the supportive attitude of lenders and at what stage the situations come across his desk. He said: “Very few of the projects coming to us have been moving on to full insolvency and there have been plenty of repair remedies and hold strategies that we can employ. With re-financing currently difficult, the emphasis is on consensual restructuring and turnaround. However, to achieve a turnaround, you need receptive market conditions in which the business can be fixed, plus access to the right management skills. Without this and access to some rescue finance, a real turnaround becomes very difficult.” There has been a steady increase in the number of distressed businesses in need of turnaround during the last six months. PwC’s report found that it is significantly harder to turn businesses around at present, although there is a sense among professionals that much of the work is still ahead in 2009 and 2010 as the downturn’s affects filter down to more businesses. Simon Freakley, CEO Zolfo Cooper Europe, says the market has taken a pause for breath. He said: “We’ve seen a marked upturn in work coming from all sectors, but with a significant focus on those most directly impacted by consumer spending such as automotive, retail, leisure, property and 14 Corporate UK April 2009
consumer/business services. At present there is a distinct feeling that the market has taken a pause for breath which has much to do with the many internal changes taking place at the major lenders – once these have been confirmed we expect another, longer, wave of restructuring activity.”
Focus on financial restructuring Financial and operational restructuring are options when a business can’t be rescued in its current form. Financial restructuring aims to reduce debt servicing costs and free up more working capital to invest in keeping the business afloat. Companies most likely to fall into difficulty at present are those that underwent highly leveraged restructurings before the economic downturn and took on a large debt servicing burden. Figures from the PwC survey show that 87% of turnaround professionals stress that raising funds for operating cash flow is now harder than at the time of the first survey and 86.7% of those polled stressed that securing cash flow is the single most important action in a turnaround. Alyson Howard, director at boutique restructuring group Meta Corporate Finance, says that borrowers need to be right on top of banking covenants because if they are broken lenders will not wait to take action. She said: “Arguably the banks are viewing covenants as a trigger rather than an early warning. Multiples used in company valuations have already moved lower than they were at their peak. In a business earning less than £1 million EBITDA, whilst one might once have hoped to see multiples exceeding five times, in the current market you would expect to see three to five times as a maximum. It does ultimately depend on the business sector. Some parts of the economy are being seen as relatively recession proof with the result that these businesses can still command decent valuations.” She added: “The options for restructuring and sourcing debt in a turnaround situation are still as they once were, predominantly asset backed, or via high risk turnaround equity funds. However, the number of choices has certainly reduced and the terms that can be agreed more expensive than
they were. The important thing is to be creative. Invoice discounting and stock finance can help in a manufacturing situation, but when faced with a service business, the solutions can be more difficult to source. Ultimately the banks have a default position now which is that the owners of the business must introduce more equity. That can be more easily said than done when the drop in property values and pressures in the mortgage market can make accessing personal capital more difficult.” The ongoing squeeze from financiers is affecting all sectors of industry and is being made worse by falling valuations, reducing the value of securities and, therefore, stretching covenants further. David Hudson, partner with turnaround specialist Begbies Traynor, said: “Few businesses are immune to this pressure from bankers and finance houses. Over leverage is one of the reasons, but also general turnover is reducing in most industries. When gearing is so high and asset values are dropping, pressure is put on covenants. Where a company might have been borrowing against a property, the values might have dropped by 40%. Loan to Value (LTV) ratios no longer stack up, so financiers say the LTV needs to be addressed as it breaks the covenants. Companies are being squeezed all over the place by this.” The greater pressure from banks and finance houses is also serving to reveal weaker businesses that had inappropriate corporate structures, but were able to hide the problems by continuous refinancing during the good times. Companies that have entered turnaround or insolvency during the last part of 2008 and early 2009 are likely to fit in to this category. Simon Freakley, from Zolfo Cooper, says that ‘papering over the cracks’ is no longer possible in the current environment. He said: “Many of the corporate failures we have seen to date have been what could be classified as poor businesses which survived longer than they possibly deserved to owing to easy access to funding which effectively papered over the cracks. Lenders are now displaying much greater caution, which some might see as being over-corrective hence the introduction of the Government schemes which have, as yet, failed to make a significant impact. The true test will come when, as we expect to see
in the coming months, a growing number of “good” businesses start to experience difficulties and will need access to funding to support essentially sound business models through troubled times.”
Operational restructuring Aside from restructuring the finances of a business, there are many more techniques applied by turnaround professionals when they are working to help a business to survive. Financial restructuring is only one pillar needed to create a stable company. There is also a need to realign the objectives or strategy of the company in question, assess the management for any weakness and analyse the cost base for any potential wastage. Jose Guzman-Bello, managing director of Consult Avila, believes that the current climate requires a restructuring professional to understand how the risks affecting a company also affect his partners and suppliers. He said: “The current climate requires turnaround professionals to have a very good understanding, not only of those risks and issues affecting their business, but also those affecting other parts of the value chain, both upstream and downstream. While doing this, businesses should explore opportunities for collaboration either with customers or suppliers to either share or reduce the risks or mitigate the impact of the downturn.” Mr Guzman-Bello is also enthusiastic about the need to think creatively in a downturn and find opportunities amid the problems. He said: “The current crisis can be seen as an opportunity to accelerate the execution of transformation plans involving downsizing, consolidation and outsourcing. The current economic crisis will also change most of the accepted rules of business. There is going to be an increase in price competition, as well as more volatility of demand and costs. Availability of cash will be the dominant key success factor, hence, the need for re-thinking business models, challenging previously accepted strategies and definitions of what is core or not to the business.” Mr Guzman-Bello recommends a crisis management action plan that is well prioritised and understood. He suggests this is only possible where
companies had already put in place aggressive management of working capital, rigorous management of credits and debt and ruthless elimination of non-added value costs. Alain Le Berre, from Huron, says that any successful restructuring must give equal importance to all aspects of the process, not just financial restructuring. He said: “Successful restructurings (meaning those which can still be considered successful three years after the fact) are those where stakeholders have understood from the outset that they have to integrate all dimensions of the restructuring (operational, strategic, financial and managerial) in one single vision and one single process. In many cases, financial restructuring is the most pressing step, but if it is to succeed in the long-term it absolutely must be accompanied by appropriate operational and strategic reviews and optimisations as well.” He added: “In the past few years, examples abound of companies with bad balance sheets that were fixed, but where operational and strategic weaknesses were left insufficiently dealt with. As a result the company had to be restructured again 18-24 months later. Many creditors and distressed investors have lost considerable money in the process – while some managerial teams lost first their credibility and eventually their jobs. There is a risk that this less-than-optimal practice may resurface in this cycle unless all stakeholders in a financial restructuring realise that it’s not just the balance sheet that they have to fix, but potentially the entire business in all its dimensions.” The oft-used cliché ‘cash is king’ is certainly true, but is also often focused upon to the detriment of the rest of a turnaround operation. Directors must be careful to keep their eye on the big picture while also micro-managing the cash flow situation. Bruce Mackay, from Baker Tilly, points out that both tracks must be managed equally well. He said: “Cash certainly is king and it is a vital job to manage and preserve cash and make efficiency gains in the cash revenue cycle, but it’s also easy to get distracted in crisis management mode and lose sight of managing the business fundamentals. There is a business to run, and, whilst a key part
of that is the cash side, if directors focus too much of their time on cash preservation a bunker mentality might set in and they might just take their eye off the ball with regard to actually running the business in the way it should be run.”
Securing private equity finance to aid turnaround or restructure Valuations are falling across the board and the cost of purchasing potentially good businesses is also dropping. This phenomenon is presenting bargains to buyers with cash who don’t have to rely on large amounts of debt to finance a transaction. Private equity funds are storing up cash and waiting for valuations to reach a bottom before entering the market and snapping up businesses that have undergone effective turnaround or are in need of financing for restructure. David Hudson, from Begbies Traynor, says he has been inundated by enquiries from investors looking for good businesses to buy out of turnaround or administration. He said: “We are inundated every day by funds, individuals and consortiums, all looking for opportunities to buy. There is no shortage of people coming forward and no shortage of people claiming they have funds ready to move quickly.” He added: “Investors are waiting for the right deal; they want to see the deal and make sure they are buying at exactly the right time. They are prepared to have a look at things, but not many suit their criteria at the moment. They have relevant sectors that they are interested in, but, at the same time, they are looking at the gearing of the business and to see if current stakeholders will take a cut on their debt. The potential for restructuring the business is also a factor, plus the strength of the product going forward.” A fear of catching the falling knife is ever present in the markets at the moment and that is influencing the investment activity of private equity funds. Alain Le Berre, from Huron, said: “There’s still considerable uncertainty out there as to how low valuations can still get and this brings on the fear of catching a falling knife. Valuing a business in this economic environment is very difficult indeed and April 2009 Corporate UK 15
The IPA –
Regulating insolvency Jonathan Birch President The Insolvency Practitioner’s Association (IPA)
in, some industries, with very wide ranges of potential top line development, it can even be a rather futile exercise.” He added: “Some distressed investors who moved out too quickly in the last 12 months got their fingers burnt. No one rings the bell at the bottom, but the market uncertainties going forward shouldn’t be underestimated. Conversely, it is important to move quickly as targets may otherwise be driven into insolvency before a deal can be found. As a result, investment opportunities must be analysed from all angles (financial, operational, strategic, managerial), both in-depth and yet also very quickly, before doing a deal.” Bruce Mackay, from Baker Tilly, believes PE funds are still entrenched and watching the market carefully. He said: “We did a dealer survey in the motor retail sector recently, in which most dealers pointed towards a recovery in early 2010. I also heard the chief economist of a major bank address a recent Baker Tilly pensions conference and predict an end to the UK recession by Q4 of 2009 or Q1 of 2010. If these crystal balls are anywhere near the truth, you might expect private equity funds to move in towards Q3 of this year. There seems to be a growing belief that that sort of timescale might just be the right one.”
intent, but argues that a phoenix from the flames scenario via a pre-pack is quite acceptable, as long as no other better buyers can be found. He said: “The questions that have to be asked are ‘would there be any other interested parties in this business and would competitors be interested in that part of the business? If there is no other interest, then it is reasonable to look at a management buyout.” He added: “As long as the administrator can demonstrate they have taken steps to make the market aware of the sale, then there is no problem with doing a deal with the existing management. They may even pay more for it because they understand the value. The management can also try to buy in key suppliers (creditors) that will be required in the business going forward. Those creditors may lose money, but will be able to work with the company in the future; they can also agree better terms with the company going forward. A Phoenix from the flames scenario is quite acceptable if done correctly.” Simon Freakley, from Zolfo Cooper, says prepackaged administrations are just one of a number of tools available to restructuring professionals. He said: “Each case needs to be evaluated on its own merits and, in certain circumstances, particularly in the current economic environment when significant numbers of jobs may be at risk, the prepackaged administration is the best route forward.”
To pre-pack or not to pre-pack? The Phoenix conundrum
Adminstration versus Chapter 11
If an initial turnaround fails to bring a business back to life, or the financial or operational restructuring fails to yield results, then administration is a route that allows a business to be run as a going concern by a third party (ie administrator) while potential buyers are found. Pre-pack administrations are a hot topic at present because of their usefulness in rescuing value from a business, but also for the ease with which they can be abused by existing management, using the process to shed debts. The recent SIP 16 from the Joint Insolvency Committee (JIC) has attempted to clarify the use of pre-packs and put the onus on administrators to get best value for a business in administration. David Hudson, from Begbies Traynor, said he is pleased to see the JIC statement and agrees with its 16 Corporate UK April 2009
The idea of introducing US style Chapter 11 regulations into the UK has been muted by several commentators, including Conservative leader David Cameron. The idea has gained more credence as an alternative to the UK’s administration process and a better method of preserving asset values and keeping businesses out of liquidation. The Insolvency Service statistics show that liquidations in the UK have increased, and are likely to increase further. There were 15,535 compulsory liquidations and creditors’ voluntary liquidations in total in 2008, which is an increase of 24.2% on 2007. The number of companies that went into liquidation in 2008 equates to 0.7% of the active register (or approximately 1 in every 150 active companies). In 2008 there were also 6,276 other corporate
insolvencies, comprising 867 receiverships, 4,822 administrations and 587 company voluntary arrangements. In total these represented an increase of 92.1% on 2007. Peter Kubik, turnaround and recovery partner with UHY Hacker Young, believes the introduction of the Enterprise Act 2002 was intended to move the UK’s insolvency processes closer to the Chapter 11 procedure in the US. He said: “This has meant that, instead of producing lengthy reports, a company is able to quickly place itself into administration allowing it to take advantage of the protection this gives from creditors in the moratorium. Where differences remain in respect of Chapter 11, is that the directors continue to run the company instead of insolvency practitioners acting as administrators. Also the directors in Chapter 11 are able to propose restructuring and seek approval from the court and creditors and then continue with the business surviving in its restructured form with the same management team.” He added: “I think creditors will be opposed to the introduction of this part of the chapter 11 proceedings, as there has been significant opposition by creditors to pre-pack sales; where directors purchase the assets of the business and effectively continue to trade. A significant change in the creditors’ perception of pre-packs would need to occur for there to be support for further amendments to our legislation to reflect Chapter 11 proceedings.”
Conclusion All the signs point towards turnaround or restructuring situations increasing exponentially during the next six months, albeit successful turnaround will be more difficult to achieve. Company directors need to adopt a proactive stance when dealing with problems such as reducing revenues and rising debt costs, rather than taking a “head in the sand approach.” If professionals are brought in quickly enough then business failure may be avoided. The other message is that, in the event of an unsuccessful turnaround, creditors and stakeholders should welcome tools such as pre-packaged administrations, because, when used correctly, they are likely to yield better value for the debtor’s assets.
Insolvency is an inevitable part of any economy as businesses fail through mismanagement, lack of finance, loss of markets and a myriad of other reasons. In the current economic downturn the business of insolvency and those professionals who practice in this specialised area of work are being thrown into the spotlight.
Mere mention of the ’i’ word can send shivers down the spines of directors, shareholders, suppliers and other creditors alike; and now, more than any other time, is the time to ensure that any help you get in this area is from properly qualified and competent experts. The Insolvency Practitioners Association (IPA) is one of the main bodies authorised by the UK’s Insolvency Service to license insolvency practitioners. It has an important role to play in setting ethical and professional standards for its members and monitoring them on an ongoing basis. Jonathan Birch, president of the IPA, says that insolvency practitioners will be experiencing a significant upturn in work at present and this is likely to go on into next year. He said it is important for all IPA members to make sure they maintain standards and don’t take on more work than they can handle. Attention to effective communication, particularly with creditors, and due regard for ethical principles are vital, but all too easily overlooked, when working under pressure. He said: “Insolvency practitioners are very busy at the moment; we are currently looking at a period of economic difficulty and the longer that period goes on the more problems businesses and individuals will have. The profession-wide Code of Ethics sets out a number of fundamental principles to guide practitioners when dealing with extra work load. They must be able to provide a competent professional service and be able to give due care to any assignment before accepting it. We would expect practitioners to assess resources and safeguard against becoming over-stretched.” The Code is supplemented by the IPA’s guidance on transparency, which stresses the importance of an open dialogue with those who have an interest in the insolvencies. The concerns that creditors
sometime express about a lack of involvement in the process can be overcome by full reporting, and the IPA’s guide is a timely reminder, particularly in the context of increasing numbers of pre-pack administrations, of the need to be ‘on the front foot’ – to both enhance the reputation of the profession and minimise the risk of complaints. Mr Birch added “If we get a complaint, as a regulator we look at the conduct of the individual and we measure it against statute, ethical guidance and published statements of insolvency practice (which in effect are mandatory practice requirements). Members can be fined and/or publicly reprimanded, or even have their licences restricted or removed if we consider their behaviour is such that the public is being imperilled by their actions. However, complaints are often misdirected at practitioners, who are in the firing line as the messengers delivering bad news – i.e. that a business has failed and that there are insufficient funds to pay creditors in full, or at all.” The IPA’s membership has increased recently and Mr Birch believes this is in part due to a new regulatory framework which empowers members to improve their own systems of operation. He said: “We now license more than 450 insolvency practitioners, having recently attracted another 20%. One of the major reasons we are picking up numbers is that about four years ago we fundamentally re-thought our approach to regulation and made sure that our visits to practitioners fulfil our responsibilities as a regulator but also provide some value for members. We thought we could be a lot smarter in the way we delivered regulation to our members, so we now ask our members every year to self-certify conformity to standards on selected cases, and through this identify any problems and amend their own systems. This means our reviews are then more about assisting the
members to improve their systems and work quality, rather than nitpicking about individual case compliance. Our present position – one in which the IPA is increasingly seen as the regulator of choice – is partly a consequence of practitioners recognising that the better regulation approach is assisting them.” The Association acts as a sounding board for technical queries and can also provide clarity and guidance on insolvency scenarios. One example is the use of pre-pack administrations, which have come in for some criticism recently with accusations from some quarters that directors use them to resurrect their businesses, leaving debts behind. Mr Birch said: “Pre-pack administrations are about the ability to quickly save a business and jobs where there is no alternative. New regulatory requirements set out the information that an insolvency practitioner has to give to creditors so they can fully understand what is happening. The business must be marketed correctly so that the best price can be obtained for the assets.” He added: “If somebody was to walk off the streets and try and buy their business back via a pre-pack, I would say to them ‘it doesn’t happen like that’. We are duty bound to do the best for creditors, so it’s about getting the best value for the business.” The IPA fosters close relationships with other trade and regulatory bodies to enable it to provide relevant services, in both formal and also less formal insolvency-related activities such as property receivership, to help its members and equip them in turn to help the UK economy out of trouble. Mr Birch added: “We do recognise that the next 12-18 months will be a very challenging time for the economy and for insolvency practitioners. We will be put on our metal to deliver an effective professional service to the business community and demonstrate to everyone that we are achieving the best outcome in saving businesses in very difficult times.” April 2009 Corporate UK 17
At the centre of our business is you.
the forensics way Mike Tallent Director Dispute Analysis & Forensics +44 (0) 207 715 5238 email@example.com
It would be more than understatement to say that forensic accountants have enough on their plates. With the economy taking a nose-dive and companies everywhere struggling for survival, light is being shed on those businesses and individuals who were “faking it” during the boom times. Even companies that played by the rules before the recession hit now need forensic accountants to help ensure hard-earned revenues are not being diverted into fraudsters pockets. Every penny counts when the top line is taking such hits and profits are so hard to come by.
At KBC Business Capital we start from the principle that every client is our So, it is certainly true that the likes of Madoff and Stanford are keeping fraud investigators on their toes. But there is another facet of current corporate life in which the forensic accountant is playing a critical role-restructuring. Of course all companies are faced with performance issues at every stage of the business cycle. However, the unprecedented and particular nature of the world credit crisis, and the ensuing fallout, has resulted in businesses suffering through levels of distress never experienced before. The demand for corporate turnaround and restructuring advice is unprecedented. But it is not just the financial and operational restructuring experts who are putting in extra hours. Forensic accountants are also in great demand during the restructuring or administration processes. The key objective of any administration process is to maximise the returns to the company’s creditors, either by rescuing the company as an ongoing concern or winding up the company to maximise creditor value, when the former option is unavailable. The restructuring process seeks to restore a company to health by implementing measures such as improving working capital management and maximising the value of the company’s assets. Both administration and restructuring lend themselves to the skills of forensic accountants, who will undertake virtually the same tasks as they would during a fraud investigation. In a restructuring or administration, it is essential to
identify the true financial position of the company in question. For example, an accurate list of creditors, and the amounts owed to those creditors, is vital; crucial decisions regarding the future of the company cannot be taken by the administrator without this information. Determining this accurate financial snapshot can be difficult; businesses requiring restructuring or administration often have systems and accounting records in meltdown. Key financial data can be hard to access quickly, which can hinder both the timeliness of the restructuring process and even the favourability of its outcome. Forensic accountants can help to reinstate a level of order amidst this initial chaos, and provide administrators or restructuring experts with some of the tools they need to sustain value and achieve a resolution. Preserving, capturing and storing vast quantities of electronic data is the first step in the process of reconstructing transactions and working through the events that led to the crisis point. The use of forensic technology techniques, such as data mining, disk imaging, and analyses of companies’ (often massive) accounting packages, enables critical data to be captured accurately. In fact, document capture and retention is vital given the possibility of litigation and / or criminal prosecutions, and the need for evidence that will stand up in a court of law. Data is required to prevent or defend litigation arising against the company in administration, or to assist in litigation against third parties to secure or recover company assets. It is often the case that parties
need to be pursued in relation to negligent or fraudulent activity. Forensic accountants often supply such accounting advice in highly complex areas. For example, in the wind down of Lehman Brothers Holding Inc., forensic accountants are helping to unravel the complex derivatives contracts, and have contributed towards developing an international protocol to enhance overall recoveries, since it is vital to ensure that an appropriate trail of evidence exists in relation to the unwinding of these trades. Typically, the forensic accountant also identifies funds and assets for recovery by the administrator(s), and prepares a complete list of creditors based on company information. Claims received from creditors can be assessed for validity by the well-trained eye of a forensic accountant, assisting the administrators in maximising the value returned. As the business world continues to experience high levels of distress, resulting in highly complicated restructurings, the technical expertise of the forensic accountant is essential to navigating through the turmoil and, hopefully, out the other side. Forensic accountants will play a key role in providing rigorous investigative processes and ordered presentation of the facts in this challenging and disruptive environment. Mike Tallent is a director with the Dispute Analysis & Forensics practice of Alvarez & Marsal, a global professional services firm delivering performance improvement, business advisory and
only client. We recognise that you have individual needs and aspirations and we take time to understand your business, to define your objectives and to tailor our expertise to provide a financing solution that makes sense to you. Combining a specialist Asset Based Lending team with KBC’s leading corporate banking division, we remain unparalleled in our ability to deliver a competitive and integrated range of finance solutions to help clients achieve their commercial goals.
KBC. Expect more.
turnaround and restructuring services.
Contact us on tel: 020 7390 4728 email: firstname.lastname@example.org or visit www.kbcbusinesscapital.com 18 Corporate UK April 2009
Restructuring a distressed business The ABL advantage
In association with:
Tim Hawkins Commercial Director Centric Commercial Finance +44 (0) 208 747 2358 email@example.com Ian Flaxman Strategic Director Eurofactor +44 (0) 113 390 7850 firstname.lastname@example.org Tim Corbett Managing Director Fortis Commercial Finance Limited +44 (0) 1892 703 500 email@example.com Adam Johnson Managing Director GE Commercial Finance +44 (0) 173 784 1328 firstname.lastname@example.org Philip Lammas Sales & Marketing Director GMAC Commercial Finance +44 (0) 207 397 4397 email@example.com Paul Beveridge Managing Director KBC Business Capital +44(0) 20 7390 4719 Paul.firstname.lastname@example.org Steve Websdale Managing Director Venture Structured Finance +44 (0) 144 425 5065 email@example.com
20 Corporate UK April 2009
Asset-based lending is a popular source of funding at any stage in the economic cycle, but it has become particularly important in this economic downturn where other sources of funding, such as traditional mainstream bank debt, is becoming increasingly scarce. Paul Beveridge, managing director at KBC Business Capital, a subsidiary of Belgian bank KBC Bank N.V., says most of his work is in refinancing and restructuring at present, with very little M&A work. He adds that some of the problems are caused by existing lenders in distress, rather than any fundamental problem with the company they are lending to. He said: “In some cases the reasons for refinance are down to problems with the lender as opposed to the company. We are currently being asked to refinance Icelandic banks, which had previously lent more than £1 billion to the sector. Whilst they are supportive of existing customer facilities in the short term, they are no longer closing any new business and this has left a hole in the funding market that needs to be filled. You can see why customers want to refinance out of those situations, clearly they are going to struggle to do anything with traditional debt facilities in the current market and they are concerned about that.” He added: “Many of those banks were aggressive in their lending criteria, meaning we can’t necessarily take the borrower out whole from that. We need a consensual arrangement where the other bank stays in for a piece of subordinated debt in the structure while we refinance term loans or working capital to the level we are able to and are comfortable with.” Venture Structured Finance is a division of Venture Finance and has provided asset based lending facilities across the UK for the last 20 years. Steve Websdale, managing director of Venture Structured Finance, says that he expected to see more activity in the first few months of this year than has materialised. He believes that once the mainstream banks have fully unwound their lending positions, it will prompt a surge in requests for ABL lending as companies have their banking facilities withdrawn or cut back. He said: “In the last quarter of 2008 we saw a 60% increase year on year in the number of enquiries for our services. I expected to see a wealth of activity in the first couple of months of 2009, but it hasn’t really happened, it’s been more business as usual. I think this is because the banks are still sorting themselves out in terms of risk management, I expect to see a very substantial level of refinance and turnaround funding requirements coming to market in the second quarter of this year because I think
the banks will genuinely start putting existing positions to the market in greater volume.” The strengths of asset based lending are most obvious in a downturn when there is a need for a single solution that isn’t subject to complex cash flow covenants. Centric Commercial Finance is self-funding via a private fund called Cabot Square Capital and is focusing its funding into SMEs at present. Tim Hawkins, commercial director, and Andrew Rutherford, sales director, believe that this ability to unlock value in different types of assets and provide a single solution to replace other more complex debt structures is the value that distressed businesses and turnaround professionals are looking for. They said: “ABL can provide a single funding solution to replace complex existing debt structures. It can also improve working capital allowing clients to expand and develop their businesses with solutions delivered to meet specific timeframes. ABL lenders also have the ability to work in collaboration, and in syndication, with other banks and private equity houses, offering competitively priced facilities.” This theme is being interpreted by asset based lenders as a realisation on the part of restructuring advisers that structuring debt against assets in the most appropriate way of arranging funding. Ian Flaxman, strategic director at Eurofactor, the ABL arm of Credit Agricole, said: “Asset based lending is certainly more in demand; this is a combination of the decline in availability of more ‘traditional’ sources of funding and a realisation on the part of advisers to business that an approach structured against the assets of a business is often the most appropriate means of funding. Commonly, an ability to leverage more against specific assets and a lower propensity for lenders to reduce/withdraw funding with little/no notice are seen as advantages of asset based lending.” Financing against EBITDA becomes more difficult in a downturn as revenues become more volatile and difficult to forecast, they also don’t always reflect the underlying value of the business, meaning a form of finance that examines the true value of the organisation’s assets has the advantage. Philip Lammas, sales and marketing director, at GMAC Commercial Finance, said: “ABL is more in demand, though it is relevant in all economic cycles. In the current economic environment it is more difficult to provide debt based on a multiple of EBITDA,
whereas ABL is robust and can provide certainty with funding secured against accounts receivable, inventory and fixed assets.” His views are supported by Tim Corbett, managing director of Fortis Commercial Finance (FCF), who said: “We are certainly seeing a greater number of enquiries from companies who are finding that the more cautious approach taken by many banks, in respect of traditional forms of working capital financing such as overdraft, is putting pressure on their existing facilities. It is particularly at difficult times like this that ABL shows its strengths by clearly being linked to asset values rather than historic financial performance.”
The ABL assessment process – viability is key Asset based lenders require more than just accurately valued assets in order to give the green light to lending. A viable business proposition that can demonstrate sustainable revenues going forward is key, particularly in a restructuring situation where business strategy, management or product offering may well change. Adam Johnson, managing director at GE Commercial Finance, said: “Intermediaries and PE houses often come to us saying they have a company in distress that needs an ABL solution. In many cases their client has the wrong capital structure in place, a poor management team and/or a weak market position. In these instances it’s wholly inappropriate to try and put together an ABL solution without addressing some of these fundamental issues as well. Otherwise you will only end up with a solution that isn’t going to be workable and will end up being restructured six months down the line in any case.” Steve Websdale, from Venture Structured Finance, says a clear restructuring plan is crucial to an ABL funding package. He said: “Asset based lending is very useful because it optimises the level of liquidity. It’s not helpful if a business that is looking to restructure in a turnaround environment hasn’t got a clear restructuring plan pulled together. We are looking for businesses that are happy to reengineer, restructure and create a viable business plan going forward. Bringing us in at the right time is also an important consideration.” Looking closely at the type of debt structure in the
Finance is a key aspect of any restructuring process and one that has to be addressed at an early stage by turnaround professionals if they are to be successful. The Asset Based Finance Association (ABFA) recently released figures revealing that more than £17 billion of asset based lending (ABL) was advanced to UK businesses in 2008. According to the figures the industry is now worth £208 billion, a growth of 9% on figures for 2007.
ABL can provide a single funding solution to replace complex existing debt structures. It can also improve working capital allowing clients to expand and develop their businesses with solutions delivered to meet specific timeframes.
business can often give a key to why it is distressed and in need of turnaround. Sometimes the debt servicing requirements can be drastically reduced if the lending is more closely matched to the business model of the business. Steve Merchant, head of Asset Based Lending Services, at Baker Tilly, co-ordinates the firm’s advice on the ABL market. He says an asset-based structure provides greater security to the lender and is favourable from a capital adequacy perspective. He said: “Asset-based lenders are well placed to support new lending propositions, but there is the challenge to borrowers to clearly articulate their plans and produce a compelling proposition to the ABL - based on current, up-to-date data and focusing on the future.” Paul Beveridge, from KBC Business Capital, said: “There is no point putting more debt in if it can’t be serviced. If the debt is geared around a multiple of EBITDA and they don’t have the same profitability going forward, then they can’t service it. If, for instance, they have a £20 million term loan on a five to seven year repayment profile, we can restructure and flip it to a revolving structure. Instead of an amortising term loan of £20 million, you could flip it to a £15 million revolving credit facility and a £5 million term loan, the loan repayment is then on a gentle, less aggressive, profile. The rest is a revolving facility, so then the concern is about servicing the interest at a more modest amortisation profile rather than the interest and a large slug of debt.” He added: “We recently refinanced a Scottish bank that put a small overdraft and a huge term loan into a whisky manufacturer. The company wasn’t going to generate a lot of cash for the next couple of years, because they wanted to mature their inventory for longer and sell later at greater margins, rather than sell the whisky when it was younger for a cheaper price. “We looked at their asset profile, which was largely receivables and this huge lake of whisky, which was maturing and would have a greater value the longer you left it. We were able to get our head around the idea that the whisky had an intrinsic value which was going to go up rather than down, so we structured a big revolving credit facility to refinance the term loan. This enabled them the capacity to execute their plan to sell less in the short term and age their whisky.”
April 2009 Corporate UK 21
Ian Flaxman, from Eurofactor, said: “Companies such as Eurofactor, where the receivables are a key asset, will concentrate on industries where the underlying debt type is suitable. The key consideration is the nature of the invoice, as we would not expect to fund invoices where there was an underlying contract or obligation that might cause difficulty in the event that we needed to collect the ledger in a ‘gone’ situation. Examples of suitable industries include time-sheet based businesses (i.e. temporary recruitment), manufacturing, haulage, printing and wholesale distribution.”
Funding out of administration
Emphasis on different industries and asset classes The more liquid an asset is the easier it is to value and lend against. Receivables (invoices) have traditionally been the remit of the asset based lender but recently there has been a significant increase in lending against inventory, plant and machinery and even property. The increase in lending against stock and inventory (as opposed to invoice finance) could be seen as a sign that many ABLs are now lending into distressed businesses. Figures from ABFA show that advances against sales invoices grew by just 6.4% in the second half of 2008 to £16 billion, while advances against other assets grew by 54.3%. This included £1.6 billion against stock, £440 million against property and £1 billion against other assets. Tim Corbett, from FCF, says he has typically restricted funding to receivables and inventory because of their liquidity. He said: “These assets are most quickly converted to cash if properly managed. In terms of distressed businesses, we are being approached by companies who have taken advice and have developed a robust plan which will see them through any current difficulties. With these businesses, providing we can get comfortable with their proposals, we are happy to support.” Most asset based lenders are concerned about not funding against assets such as property until the bottom of the market has been reached, regardless of whether the business is classified as distressed or not. Philip Lammas, from GMAC, says the key is to ascertain if we are near the bottom of the cycle where asset values become more consistent before increasing the range of funding options. 22 Corporate UK April 2009
He said: “Given current market conditions many businesses have increased working capital needs and we are here to provide a solution to those needs. At the moment we are more focused on funding against receivables and certain types of inventory. Once the market has bottomed out it will be possible to increase funding against plant and machinery and property, as asset valuations will be more consistent.” The type of industry is also key as the most suitable businesses are those traditional style businesses with much of their value tied up in tangible assets such as inventory, plant and machinery or property. Figures from ABFA show that 1,049 deals were done in the distribution sector during the last quarter of 2008, 524 in the services sector and 373 in manufacturing. There were just 42 ABL deals in retail and 12 in construction. Centric Commercial Finance has even split its business into separate brands for the healthcare and pharmacy sectors, where they provide invoice financing facilities against NHS and local government invoices. Pharmacy Partners provides working capital to independent pharmacists, releasing cash tied up in their NHS dispensing and Resource Partners focuses on working capital facilities to domiciliary care businesses, children’s homes and fostering agencies who deal with public sector bodies, in the majority of cases local authorities. Eurofactor is another asset based lender that looks closely at the industry and type of debt associated with it, before moving the lending process forward. The firm is primarily a funder of receivables, although it also considers stock, plant and machinery and property as secondary forms of security for further advances.
Changes to a businesses structure and management are likely to be much greater when it is being bought out of administration. In this case there may be a turnaround professional, an administrator and interim managers involved in the business, all having a say regarding its future direction. Asset based lenders are still willing to fund in these situations, but they need more clarity as to the business plan. Steve Websdale, from Venture Structured Finance, said: “We are very active in the turnaround market at present and have worked with pre pack administrations. The crunch in this situation is the emergence of a viable business model. The changes that need to be made must show the business can be successful in its new form, we have always worked very closely in that sector and there is no doubt funding through pre-packs will continue throughout 2009. It’s a tough market and the crucial issue for us is clarity of thinking from the encumbent or new management team concerning the future viability of the business. We are looking for viable businesses emerging from a difficult market.” Paul Beveridge, of KBC Business Capital, suggests that one of the key questions to ask during a prepack is ‘what’s going to be different?’ He said: “We wouldn’t support a management team looking to ditch some creditors; we need to understand the turnaround plan and what’s going to be different this time. If that’s the case we will take a look.” A strong experienced management team and a good underlying business are the keys to funding from administration. Tim Hawkins and Andrew Rutherford from Centric, said: “We funded a management buyout of the UK’s largest manufacturer of furniture components, when it fell into administration. The MBO of South Yorkshire–based BLP UK Limited was secured with an asset based finance facility comprising invoice discounting and a plant and machinery loan.”
Thoughts for the future – asset based lending into 2010 and beyond Asset based lending is suitable for all types of economy and is not exclusive to a downturn, although its influence has increased as banks have continued to restrict credit lines and increase their spreads, fees, collateral requirements, covenant restrictions. Adam Johnson, from GE Commercial Finance, says he sees the popularity of ABL increasing in 2009 and beyond, and holds the view that ABL, as a core product for funding, is here to stay for a long time.
He said: “Liquidity remains at a premium and with refinancing situations, securitisation or receivables financing approaching maturity, there is an increasing need to look at alternative options. Asset based lenders come into play because securitisation markets and some of the bond markets are closed at the moment. We are seeing an increasing momentum building at the moment for ABL solutions.” He added: “There will come a point when liquidity will return to the market and the demand for ABL will not be as great as it has been this year or next, but I think this current environment has brought ABL to the forefront of people minds for funding in the UK and will continue to do so in years to come.” Philip Lammas from GMAC, says there are great opportunities for ABL lending across a range of businesses from large to very small.
He said: “The economy and the attitude of the clearing banks to lending will have a significant impact. We see great opportunities arising for ABL as a primary source of working capital and turnaround finance across the range from small owner managed enterprises to mid-market and large corporate businesses. ABLs such as GMAC Commercial Finance have always been creative, solution providers and this will continue for businesses that want to refinance, restructure or require additional liquidity during a turnaround.” Some ABLs believe their pan-European status, owing to support from big European retail banks, will help them to carve a niche for ABL lending across Europe. Tim Corbett, from FCF, says that his company’s ability to provide pan-European facilities will put
The complexity of construction disputes The construction industry has long been one of the most fertile industries for contract disputes because of the power wielded by big contractors and the general ignorance of subcontractors to the power of the commercial contract. The current economic downturn hit the construction sector early as both commercial and residential building projects were put on hold. As construction firms continue to plunge into distress or insolvency, the levels of disputes are ramping up and the skills of specialists in the vagaries of commercial construction contracts are in high demand. Rob Pearce is a commercial contract consultant and quantity surveyor who works with insolvency practitioners, litigators and turnaround specialists on contract disputes. He said: “When an insolvency practitioner is appointed to a construction company (main or sub contractor) they may get us involved because they need specialist advice and need to put people on the ground who speak the construction language. This will enable us to attain a quick understanding of the situation and take appropriate steps to progress matters promptly.” Mr Pearce says the subcontractors are their own worst enemy while contractors take advantage of that. He said: “Subcontractors don’t always understand
the contracts they sign. We see thousands of contracts that are badly prepared, it’s almost a joke on site that ‘the contract is in the drawer somewhere’ they are not thinking about what’s going to happen when something goes wrong. The standard of professional education within the construction industry, at a site level, is pretty low.” He added: “Big construction firms take advantage of subcontractors because they are in such a strong bargaining position. Even if the subbie reads the contract and objects to certain clauses, the contractor can just shop around and find someone else to do it.” In an insolvency situation there is often significant value in a contract that can be realised for the benefit of creditors, however insolvency practitioners must be very careful to thoroughly read contracts before initiating insolvency proceedings because of certain clauses. Mr Pearce said: “Generally construction contracts contain a clause that triggers a termination in the event of insolvency and, more frequently,
them in a good position to offer a competitive product during the next few years. He said: “Our ability to provide a pan European facility, to a prospect group, where the parent is in one market but the operating subsidiaries are based elsewhere has given us an edge. While other ABLs have approached this market with a one size fits all approach, by trying to hive assets back into a friendly legislative jurisdiction, time will tell whether these structures are robust enough to survive the economic shocks that we have seen in the various European countries.”
Rob Pearce Contract Consultant Robert Pearce Associates +44 (0) 1474 708888 firstname.lastname@example.org
no further payment until a certain time, which can be up to 12 years. These clauses are common it’s the mentality of the industry, where everybody is intent on kicking each other in the proverbials.” He added: “We have been called into a number of situations where the insolvency has been advertised by the practitioner and it says they’ll put the company into a liquidation or CVI and then collect the debt. The inexperienced liquidator will come to us after three months and say they are having difficulty collecting these debts. We’ll take a look and find these termination clauses. If an insolvency practitioner takes a company into insolvency, without considering the full consequences, it can be very dangerous.” The Construction Act is another area of influence and is something that insolvency practitioners should be aware of. A recent change to the act has tuned a few things up in favour of sub contractors but there are still pitfalls. Mr Pearce said: “In the old act any pay-when-paid clause will still be valid in the case of up the line insolvency. If a subcontractor is working for a contractor and the contractor’s employer goes bust then the contractor had no liability to the subbie. The same is true further down the line for sub-sub contractors.” April 2009 Corporate UK 23
Get on the right road
Distressed SMEs Small Business Advice When small businesses do get into trouble they are often unsure where to turn in order to get the advice required to help them out of trouble. The financial or strategic expertise is often not available within the business and it can be prohibitively expensive to bring in highly paid consultants, turnaround professionals or interims. One alternative is to approach an experienced debt adviser and insolvency practitioner such as Beverley Budsworth, managing director of The Business Debt Advisor. Ms Budsworth says that a combination of declining turnover and bad debts can lead to serious cash flow problems. Those cash flow problems can, in turn, lead to redundancies and operational issues when reduced staff numbers lower the operational efficiency of the business. She suggests that cash flow management is one of the critical issues that SME managers must control. She said: “I advise directors to review debtors and keep on top of overdue invoices, if necessary, offering good debtors extended terms. Ensure that your relationships with your better customers are solid and
get rid of customers who won’t pay or can’t pay, we can all be busy fools supplying goods and services to people who do not have the money to pay.” Many businesses are in trouble because they are having difficulty servicing interest payments on debt. Ms Budsworth says this is a particularly difficult issue to deal with, as the banks are likely to have security over the company’s assets as well as directors’ personal guarantees. She said: “The directors are reluctant to consider options which could mean that their personal guarantees will be called in, however banks are keen for the businesses to survive and have set up specialist teams to help businesses through this difficult patch.” She added: “It is vital that you speak to your bank and make sure you present them with potential solutions, not just problems. Make sure you are prepared and have recent filed accounts, management accounts and forecasts for the next year or two so the banks have the necessary information on which to make an informed decision as to whether to continue financial support.” Distressed businesses need to find ways to provide
Small Business Financing Small and medium sized enterprises make up a large slice of the UK economy and are also feeling the pinch at present, in some cases more acutely than larger businesses with more resources. Many SMEs are reliant on big customers for large proportions of their revenue and are therefore more susceptible to economic turbulence, particularly if their big customers are struggling. Davenham Group Plc specialises in providing business finance to UK small and medium sized businesses that choose not to or cannot access mainstream finance. The group provides trade and asset finance to a maximum of £3.25 million for new applications and is helping SMEs at a time when other forms of finance are non-existent. Martin Risman, South East divisional director of Davenham Group, says that enquiries have more than doubled during the last 12 months as the downturn bites. He said: “Businesses are short of cash and want to leverage their assets. Most enquiries are from cash starved businesses to support restructurings, turnarounds or pre-packs, though there has also been some
24 Corporate UK April 2009
recent transactional activity seen.” He added: “We have a limit of £3.25 million for new funding applications, but the majority of proposals received at the moment are for less than £1 million. Smaller businesses in particular are struggling in the current climate, as they have to implement extremely tight cash management. They seemingly aren’t getting much support from mainstream banks, but they can potentially access the funding they need from us. At the moment our phone is ringing most days for most of the day.” Mr Risman says that the advantage lies in getting close to SMEs and really understanding their assets and business model, without, necessarily, the need to see complex forecasts. This enables Davenham Group to get comfortable lending where a mainstream bank might not. He said: “First we look at the quality of the asset we are funding, to ascertain if there is tangible and collectible security. We then look at the trading prospects of the business. Many firms are struggling at the moment and, while we do our best to assess the viability of small businesses, it ‘s increasingly challenging for them
Beverley Budsworth Managing Director The Business Debt Advisor +44 (0) 845 465 0065 beverley.budsworth@ thebusinessdebtadvisor.co.uk
relief from creditor pressure if they are to continue as a going concern. There are a range of solutions available for businesses which offer protection from creditor action, should dialogue fail. Ms Budsworth advocates the use of an Individual Voluntary Arrangement (IVA), with an interim order for an individual or an administration for a limited company. Both procedures freeze existing creditor action and prevent any new action. She said: “It is so important to get advice in order to identify the most appropriate solution to your problem as one size certainly does not fit all. If dialogue with creditors has failed, qualified professionals (via a recognised professional body) can often persuade creditors to agree a freeze on action whilst payment proposals are drafted.” In the event of insolvency becoming unavoidable, businesses should always start with a full ‘fact find’ and detailed diagnostic checks. Ms Budsworth says it is crucial to effectively manage clients’ expectations. She added: “If clients know what will happen and what they need to do – a positive outcome is more achievable.”
Martin Risman Divisional Director Davenham Commercial Finance + (0) 207 968 2050 email@example.com
to hit sales and revenue projections.” He added: “In an ideal world you need comfort that the plans they are putting in place are sustainable, but there is often only so much information you can expect from an SME, unlike a large corporation. They may not have the systems and support to provide detailed cash flow forecasts, so you need to take a view on the likelihood they will achieve their targets. We absolutely need to understand their plans, but the information behind those plans varies from proposal to proposal.” Davenham Group is funded by a syndicate of banks led by RBS and recently completed a refinancing exercise which will secure funding for the next two years. The group spreads its lending risk over 4,000 clients in a variety of market sectors. The group is not lending any new money on property at present, but lends against plant and machinery, debtors and inventory to provide commercial funding solutions. For further information go to www.davenham.co.uk or call 0845 402 2470
A wholly owned subsidiary of Crédit Agricole, one of the largest banks in the world, EUROFACTOR has the strength and commercial appetite to deliver much needed liquidity to UK businesses facing turnaround situations. We recognise that corporate restructuring and turnaround situations demand a comprehensive understanding of the business seeking funds – and the management team involved. Our fundamental aim is the creation of stability through an immediate release of liquidity and the delivery of ongoing funding, enabling the management team to drive their business forward with greater certainty. The Receivables Finance facilities that we structure for the business are not dependent upon existing company profitability – so long as the reasons for profit downturn have been identified and a means of resolving them is in place. Early involvement is often critical to the success of a turnaround transaction.That’s why we are asking you to get in touch now. To set your business on the road to recovery, contact us on 020 7517 3022
The Interim Advantage Green Park
The importance of interim managers in turnaround and restructuring Interim Partners Q&A
The use of interim professionals is a growing trend in the UK, as the exacting economic climate demands more pace and efficiency from businesses of all shapes and sizes. The immediate need for changes in strategy, refinancing, new product and marketing initiatives or organisational restructuring very often demand importing highly specialised skills and experience.
Doug Baird Interim Partners +44 (0) 1423 531022 firstname.lastname@example.org
Is Interim Partners experiencing an increase in demand for the expertise of interim managers in the challenging economic conditions at present? There are opportunities for turnaround directors but not as much as we had hoped. A number of our private equity clients are telling us that they are seeing a lot of opportunities on the horizon although these are yet to translate into assignments for our candidates. We are also seeing a lower than expected number of opportunities from channels such as banks, accountancy firms and specialist lenders. Some of the banks are engaging less with the turnaround community because they are more likely to put a business into administration than risk more money attempting to turn it around. Anecdotal evidence supports this: a colleague attended an IFT meeting and was surprised to see so many turnaround specialists all reporting to be out of assignment. Are there a common set of issues that can lead firms into a distressed position (i.e. poor costing, lack of flexibility)? How can interim managers help in these situations? Unsurprisingly there are always common issues that lead to a company being in distress. Poor management is normally always a key factor however the downturn has caught many good managers by surprise. Indeed some companies may have had good management teams in place but have been overwhelmed by the sheer scale of the decline in demand and did not get additional resource in quickly enough. Sometimes there is just too much to achieve in a very short space of time and it is in this circumstance where interim managers can really assist. We have heard the expression “I wish I had brought in an interim manager sooner” more times than we would care to mention. Are there particular skills that interim managers need to master when dealing with distressed businesses in turnaround? Severely distressed businesses are not for the faint hearted so experience is an obvious but vital component. Turnaround professionals need to quickly 26 Corporate UK April 2009
grasp the underlying issues for underperformance and continually make the right decisions for the business no matter how hard they may be. Communication is vital and the ability to get the right people on side and motivated again are equally important. High quality interims really understand that they need to engage with a number of stakeholders. They will communicate with banks, private equity investors, lawyers and accountants as well as the management team and employees. Drawing together all the stakeholders, successfully communicating to them and gaining consensus is a skill in itself. Are you involved with private equity funds which need to bring in expertise to help distressed businesses they have just added to their portfolio? We work extensively with a number of traditional private equity funds who may have issues within their current portfolio as well as distressed debt investors and hedge funds who are exclusively focused on turnaround opportunities. As distressed deals tend to be completed within a matter of weeks investors need to pull together a management team quickly to advise on the deal and implement the post buyout strategy. This is where Interim Partners has a great track record of introducing experienced chairman, chief executives and finance directors with restructuring experience. We identify them in a matter of days rather than months. Which industries are most in need of interim managers at present in your experience? Poor management is a problem that is not unique to one sector therefore it is difficult to pick one industry above another. We do know through research that the Interim Management Association has undertaken that some sectors use interim managers more than others - such as financial services however we as a business also perform very well in markets such as FMCG, retail, manufacturing, utilities and construction and support services. In the context of turnaround and restructuring it is across the board.
Steve Baggi Green Park +44 (0) 207 399 4300 Raj.email@example.com
Do you have any examples of firms you have helped to navigate the difficult economic environment? What sort of advice did you provide? We have assisted many of our clients both large and small in reducing their cost base whilst simultaneously attempting to protect their existing revenue. Cutting ones cloth accordingly and structuring the business so it benefits when the market recovers is an area where we have successfully introduced interim managers. In the good times when bank lending was more plentiful, working capital and cash management was not always the highest priority. In today’s climate interims with these skills are in high demand. If we could distil down our advice to one single factor we would urge our clients to react now, don’t be afraid to ask for help or bring in fresh talent. Taking the initiative and being proactive is preferable to have the bank call you in for an urgent and unpalatable meeting. What are your thoughts for 2009-10, do you see more work for interim financial directors (FDs) as the recession deepens? Very much so. This does not always mean the replacement of existing finance directors, but in many cases supplementing them with additional resource or expertise. The FD who is very good at helping to grow a business may not be the right individual in the current climate. Clearly, appetite plays a big part and an experienced interim FD who has managed businesses in previous downturns may be better placed to steer a business through the current one Do you have any examples of recent interim placements in a turnaround situation? We have had numerous assignments where cost reduction and cash management skills have been important. The best strategy can fail if the wrong people are in place to deliver it. Recent placements include an experienced interim finance director and supply chain director into a severely distressed multi-site retailer. We also introduced an executive chairman to an investor buying an underperforming subsidiary of larger plc.
Steve Baggi, managing director of Green Park, says a significant number of organisations are reducing their permanent headcount as economic conditions worsen, but still have a pressing need to implement different projects and programmes within the business. Refinancing initiatives are a particular priority. He said: “There are a lot of businesses that are too highly leveraged and simply can’t afford their debt anymore. Banks often want a fresh team and a fresh approach - people who have experienced and successfully handled a turnaround scenario before.” He added: “Some of the most frequently required skills include speed of decision making and the proven ability to make organisations more efficient and effec-
tive, coupled with financial and cost management skills.” Mr Baggi says the client base at Green Park has changed recently, with more enquiries coming from private equity firms looking for interim executives to help struggling portfolio firms. He said: “Our client base now includes a far higher proportion of private equity and commercial banking operations. They want to bring people in to the company to help them reclaim the debt and, naturally, they then begin to have much more influence in the running and management of the business.” He added: “We have done a lot of work with
Daily bad news and loss of conﬁdence in the economy means SME businesses have been operating against a background of paralysis in decision making. Tomorrow’s most successful companies are the ones actively making decisions today. But good decisions require two essential ingredients: good ﬁnancial information and good people. The challenge for most SMEs is timely access to both ingredients at a price they can afford – it’s a ﬁne balance. Demand for Isosceles’ experienced part-time and interim Finance Directors (FD) has increased signiﬁcantly recently. The demand is being driven by both smaller organisations who now realise that they need access to FD skills for the ﬁrst time and also larger organisations who have come to realise that they neither require nor can afford these skills to be on site full time. This recession is affecting different sectors in different ways. For SME’s the particular challenges they face include: • over reliance on a few key customers • product/service offerings which are too narrow • inefﬁciencies which could be glossed over during good times now represent boulders impeding business • lack of cost control and failure to act quickly and decisively • poor culture of cash and proﬁt forecasting • failure to innovate and use imaginative business solutions • poor communication within the organisation and an unwillingness to face up to current business reality
private equity firms during the last couple of years, delivering them individuals with specific turnaround experience. CEO’s and FD’s are in strong demand as clients want leaders and decision makers, and the secondary phase of their resourcing plan tends to then focus on stock management or supply chain professionals.” In the interim turnaround space, there is a limited pool of proven experts. Green Park draws on its established, trusted talent pool to help clients undergo transformation – in turnaround situations there simply isn’t the latitude to gamble. Mr Baggi says that consumer-facing industries tend to be faring worst at present, and are most in need of interim assistance. He said: “Property and retailers are struggling, as are supply chain, logistics and business services companies. We will see more activity in the turnaround space from the summer time. Companies, banks and individual speculators will want to invest in businesses that have long term value and are available at depressed valuations.” www.green-park.co.uk
At Isosceles we understand that SMEs need FDs with different skills to those of major corporations, in particular Isosceles FD’s have the ability to: • • • •
be decisive roll their sleeves up and implement solutions - not simply advise from a distance make difﬁcult decisions in a dispassionate, yet sensitive manner help management identify the minimum resource required to execute the business plan • be innovative and imaginative in determining solutions • communicate tough messages exceptionally well to the Board, investors, bank, employees as well as customers and suppliers These skills are learnt through difﬁcult experience.
Being an ambitious SME company is challenging at the moment, but with focus and the right team there’s still money to be made…… Whilst the economic news will continue to deteriorate there are grounds to be optimistic. The paralysis is passing, companies are starting to make decisions even if these involve re-organisation and redundancies. There are signs that companies are attempting to determine their own destiny. Businesses will need to plan for tough conditions for at least another three year window. Good companies will capitalise on opportunities and emerge stronger. SME’s can be much nimbler and more customer centric than their larger competitors. Isosceles is a leading provider of interim, part-time and outsourced accounting and HR solutions to SME companies.
Isosceles Finance Limited Centurion House London Road Staines, Middlesex, TW18 4AX
Our largest client is a fully listed £200m turnover company, our smallest a University spin-out. We boast four TechTrack 100 winners within our client list.
Tel: +44 (0)870 770 9084 www.isoscelesfinance.co.uk
We have the experience, people and processes to help turn this time from a period of threat into a period of opportunity for you.
Turning around the UK economy
Legal Advice in
Restructuring and Insolvency Restructuring a debt position, completing a distressed takeover, or dealing with the complexities of an insolvency, are all situations that require legal advice to put the right structures in place and avoid violating any regulations. This is particularly true when it comes to insolvencies where there are likely to be substantial disputes between creditors and the insolvent party.
Neil Chesterton Finance Director Turnaround Management Association (TMA) +44 (0) 207 496 1010 Neil_chesterton@tmp.co.uk
In association with:
urning around the performance of a business in distress can be a complex and involved process. It may involve a range of professionals from financiers, equity providers and turnaround professionals to interim managers, valuers and lawyers. When a business recognises it is in distress and falling dangerously close to collapse it needs to take independent expert advice to help it survive. Admitting that need for help is a big step for company directors, but it is only the first step. Many don’t realise how difficult it is to assemble the right team with the right skills to make a business a success and stop it falling into insolvency. Initially a turnaround professional will assess the business, but they may need to restructure the finances, alter the management team and change the corporate strategy in order to achieve success. The Turnaround Management Association (TMA) is designed to facilitate this process and acts as a forum for all professionals with a link to the business of turnaround to come together, network and exchange ideas. The TMA was founded in the USA in 1988 and is headquartered in Chicago. The UK branch was set up in 2001 and there are also other established chapters in Europe, including Netherlands, Italy, France, Germany and Spain. It acts as a trade body and has a broad range of members across all the relevant specialisms. Neil Chesterton, finance director of the TMA and a turnaround specialist with The MacDonald Partnership, says the business of turnaround can be explained with the analogy of a three legged stool, representing turnaround management, turnaround finance and restructuring skills and experience. If one of those “legs” is missing, the turnaround is likely to fail. He believes the TMA is the perfect forum to find all these skills. He said: “I think it’s very important that people who belong to the TMA see it as a networking opportunity. The variety of different skills around increases the chance of referrals. TMA events are a likely place to meet someone you are going to work with in the future. The three legged stool is a good analogy for the TMA’s appeal because you rarely see successful turnarounds without finance and the same is true with management. We work mainly in the restructuring side but it doesn’t work without the other elements.” Mr Chesterton says the key to turnaround is to make sure a team is put in place early enough to make the necessary changes before cash flows get too tight and money runs out. He said: “If we get in early enough we can address the element of delusion in the management, who are still thinking about how good things are going to be and are not 28 Corporate UK April 2009
facing up to the fact that things are going to be worse than they expected.” He added: “It’s very much like a bereavement process they have to go through. We help them to understand what the options are and what is needed to solve the problems. They have usually never been in this situation before and may be exposed by a guarantee or a charge on their house that’s worrying them more than their role as a director.” Mr Chesterton describes a “hand holding process” required to help the management work through their problems. He said: “We work through the issues from a financial point of view, creating realism about cash flow and projections. Too often we get situations where people have not confronted the issues early enough and their options are limited. The pressure is greater and the timescales in which to act are shorter. It is difficult to avoid insolvency procedures in this scenario.” The TMA is also very keen to collaborate with other organisations and bodies in the turnaround and insolvency sectors in order to provide the best range of services and support for its members. Mr Chesterton said: “Collaboration with other organisations that are like minded is useful in trying to find solutions for troubled companies and helping the economy in the wider sense stand on its feet. There is pressure on all industries because the banks are under water and that gives them fewer options to help in work-out situations. We are, however, seeing incredibly generous support to work out from banks and lenders, in certain sectors, because they have very little choice.” He added: “It’s important for professionals to be members of bodies like the TMA because the turnaround community is not a big pond. We have tried through the years to have a broad dialogue with associated bodies and now feel there is a more meaningful dialogue between the various bodies in that community.” TMA is also supporting a training initiative called Fundamentals in Turnaround Management which will broaden the knowledge of those working in turnaround situations. See the TMA website www.tma-uk.org for further details.
Robert Festenstein Sole Principal RHF Solicitors +44 (0) 161 839 9009 Robert@rhfsolicitors.co.uk
Richard Wolff Head of Corporate Recovery and Insolvency JMW Solicitors LLP +44 (0) 161 828 1990 firstname.lastname@example.org
Prolonged pressure on the economy is resulting in more and more businesses falling into distress and, subsequently, more falling further into some form of formal insolvency procedure. This ‘ripple effect’, which started in the financial institutions, reached into the construction and automotive sectors before the end of 2008 and is now disturbing the once calmer waters of manufacturing, retail and services. Insolvency Service statistics show there were 4,607 compulsory liquidations and creditors’ voluntary liquidations in total in England and Wales in the fourth quarter of 2008. This is an increase of 11.9% on the previous quarter and an increase of 51.6% on the same period a year ago. Companies staving off insolvency are signalling the importance of cash and also how difficult new money is to come across in the market. In either of these situations it is imperative that a good restructuring and insolvency lawyer is part of the team that helps your business deal with the problem.
Financial restructuring in a difficult debt market Damon Watt Associate EMW Picton Howell LLP +44 (0) 870 070 6000 Damon.email@example.com
Richard Tett Partner Freshfields Bruckhaus Deringer +44 (0) 207 936 4000 firstname.lastname@example.org
Getting the finances right is one of the biggest steps in pulling a distressed business back to a healthy position. This economic crisis is the first time during the last 20 years that the UK has seen a completely non-sector specific wave of restructurings. This has meant a wide variety of different debt structures and business models for restructuring lawyers to deal with. Richard Tett is a partner in the restructuring and insolvency group of Freshfields Bruckhaus Deringer, he says debt in many different sectors is starting to default as we move further into 2009. He said: “If we roll back to last autumn and look at what debt was defaulting, it was largely real estate (including opco/propcos), house builders and structured finance/ financial institutions. Then it moved into the automotive sector and now it is being seen across sectors such as chemical manufacturing, hotels, suppliers, shipping and construction materials. It is visible in pretty much anything April 2009 Corporate UK 29
Administration requires that the company is insolvent; Chapter 11 does not thus providing a company with the flexibility to use the process before becoming hopelessly insolvent. Administration is frequently commenced too late to achieve a beneficial reorganisation of the business.
30 Corporate UK April 2009
insolvency and distress. Mr Tett says companies must try and find innovative ways of stretching their cash or staving off hitting the cash wall. He said: “Businesses must look at their cash management and see what they can do to cut cash spend. If that is not enough, the answer may be an interest standstill, or switching off amortisation and all debt servicing to provide the liquidity and time to pull together a restructuring plan before the business runs out of cash. Given the level of value impairment, it is increasingly the case that a restructuring requires one or two of the junior layers of debt to be left behind or equitised.”
Advice for creditors and insolvency practitioners dealing with delinquent directors If restructuring is unable to save a company in the turnaround phase, then it is likely to fall into some form of formal insolvency procedure. In this situation creditors are in serious danger of losing all or part of their investment. An administrator or liquidator will operate the process with the interests of the creditors in mind, but it is a good idea to appoint a lawyer to fight your corner and help retrieve the maximum returns available. Robert Festenstein is the sole principal at Manchester-based RHF Solicitors. He says advice differs depending on the creditor, but advises legal action as the best course for recovery of monies from a distressed debtor. He said: “If the creditor has supplied services and they’ve not been paid, my advice is to sue. You should initially write them nice letters. Often we’ll ghost a letter for a client, as sometimes people think that letters from solicitors are seen as the last resort; that normally works quite well. Even if you only get £10,000 back from £15,000 you were owed, at least you might have covered your costs. That is a better way of dealing with it, but if that still doesn’t work, we sue them.” Damon Watt is an associate in the restructuring and insolvency practice of law firm EMW Picton Howell. He says that his firm can advise on the strategic options available for companies and creditors, secured or otherwise, during an administration or other insolvency process. He also provides advice on court applications, reports and the disposal of businesses and key assets.
Within the liquidation process he can advise insolvency practitioners and creditors on the protection of assets and the validity of creditor claims. Insolvency practitioners often have problems getting the directors of insolvent businesses to comply with the process of returning monies which are due to them from the companies. Mr Festenstein advocates using your legal armoury to your advantage. He said: “If we are dealing with a liquidator who is having trouble with the director, then there’s a whole host of legal techniques that can be used, in particular his private examination at court. If that is necessary often the court will order that the director pays the costs of this exercise.” He added that in certain situations insolvency practitioners need more tools to bring a bankrupt in line. He said: “It actually doesn’t matter in some cases if you get an order from a court suspending an individual’s discharge. If you’re dealing with a crook they’re not going to care, they’ll set up their business with a wife or brother. You can then require him to attend court and give evidence on oath as to what he’s been doing with his business. If he doesn’t turn up you can have him arrested, or if he’s being particularly unhelpful, and it is justified, the court will grant a warrant to enable you, with the court bailiff, to search his house or his business. You can, with a court order, divert his post to your office or to the insolvency practitioner’s office. You can get any information from anybody if the court is satisfied they have information relating to a bankruptcy or a liquidation.
Protection for directors against creditors The directors of a distressed business can also use the law to find protection against creditors who may be demanding full payment of outstanding debts or trying to push the business into insolvency at an early stage. A corporation in distress, in the first instance, may need to negotiate with creditors and extend credit terms. If the situation is more formal and they are facing winding-up proceedings, then they may need to consider putting in place a corporate voluntary arrangement (CVA). Robert Festenstein, from RHF Solicitors, said: “Instead of not paying people in the sense that ‘I owe this guy £10,000 and they’re going sue me,’ the best thing to do is come to an arrangement with them. Don’t hide from them, ring them up and say
‘times are hard, I know I need to pay you and there’s no avoiding that, but I’m very sorry and it’s all very difficult, but I will pay you £1,000 now and we’ll have another chat in a couple of weeks’ time, when I should be able to send you some money.’ Make an agreement with your creditors so that they don’t get stroppy with you.” He added: “If they’re facing proceedings in the winding-up court, or, alternatively they’ve two or three court cases against them, they might consider a CVA, which is a formal regime covered by the Insolvency Act 1986. You can bind creditors into the CVA, even without their consent, provided you secure 75% of those voting in a creditors meeting in favour of a CVA. So you can actually sort things out that way and they’ll have to live with it.” Damon Watt, from EMW Picton Howell, says directors are often unknowingly exposed to personal liability when their company faces financial difficulty. He said: “Continuing to trade and incur liabilities when there is no reasonable prospect of avoiding insolvent liquidation is known as wrongful trading and may result in directors incurring personal liability. Directors need to be alert to that risk and when the need so arises take steps to minimise that risk and losses to creditors. The key is knowing when to take such steps. The fact that the bank may not have foreclosed is not an appropriate yardstick for the directors to use in determining whether to cease trading and take insolvency advice.” He says that directors must consider the financial position of the company in view of current market forecasts and predictions. This can be done by regularly reviewing the balance sheet and cash flow positions. He added: “Any decision to trade on should be documented appropriately. Professional advice should be sought from lawyers and accountants and consideration should be given as to what options are available to re-structure the business or if necessary what appropriate insolvency options are available which may include appointing an administrator and obtaining the benefit of a moratorium (and therefore the breathing space) and protection from creditors whilst further options are explored. The statutory moratorium that comes into effect when a company enters administration (or takes steps to initiate the administration process) prevents creditors from taking
or continuing any legal process against the company. We provide directors with the support and advice necessary to facilitate the above, therefore protecting their personal positions and that of the company.”
A legal perspective on the pre-pack problem The pre-packaged administration has had some bad press recently in the context of directors buying back their own companies. While they can be misused they are also seen as an essential tool for maximising creditor returns. Richard Tett, from Freshfields, believes the transparency of the new Statement of Insolvency Practice (SIP16) from the Joint Insolvency Committee (JIC) should help to lift the stigma. He said: “The transparency of the new SIP is to be welcomed, as it’s not in anyone’s interest for pre-packs to be misused by directors filing for insolvency and buying out the back end inappropriately. The SIP allows creditors to look at the process and to challenge the sale by the administrator. The transparency is an important step forward.” He added: “The pre-pack allows businesses to be sold as a whole or in large part, meaning that the business is preserved and more employees can be kept on. It can also be the best way to maximise value for the creditors. The pre-pack is the solution to the fact that the business is in financial difficulties – the pre-pack is not the cause of those difficulties. Sometimes this seems to be lost on commentators.” Richard Wolff, from JMW Solicitors, says that the pre-pack regime offers an easier, quicker and cheaper method of providing viable businesses with a turnaround/restructuring vehicle, than trying to trade the existing company in administration with the difficulties associated with funding that trade, the incurring of further trading losses and the potential damage done to the goodwill of the company’s business.” He said: “While insolvency practitioners need to ensure the facts of the case support the need for a pre-pack and that full disclosure of the circumstances leading up to the pre-pack and the deal particulars are given, the pre-pack has in many cases proved invaluable in effecting the rescue of the whole or part of a business as a going concern, albeit rarely within the former company shell. Pre-packs are certainly in vogue at present and can offer many attractions to both insolvent companies and purchasers.”
with heavy leverage, a significant reduction in sales volumes or major pricing pressure.” He added: “It’s a bit of a double whammy in some ways, cash reserves built up in the good times at the front end of 2008 are being emptied which creates liquidity pressure and covenants are also under severe strain. Many banking covenants are tested quarterly on a last 12 months rolling basis. As Q1 08 is taken out and replaced with Q1 09, you remove a strong quarter and replace it with, what was for many, a much poorer quarter. That can generate a significant swing in the numbers and result in covenant breaches. As testing pushes out through mid May into June plainly Q2 08 will be replaced by Q2 2009. This has the same effect and, for some businesses, will be when the truly dreadful figures appear, so more covenants start to be breached.” This covenant breach bonanza has, understandably, made banks nervous and led to a retraction of credit and a stiffening of terms. Many companies are finding it increasingly difficult to obtain additional funding for investment or even to retain existing facilities and levels of borrowing with their financiers. Richard Wolff, Head of Corporate Recovery and Insolvency at JMW Solicitors in Manchester, says banks and other corporate lenders are looking to minimise their ongoing exposure to risk in their lending portfolios as they continue to face more stringent liquidity requirements. He said: “The squeezing of headroom in overdraft facilities and possible non-renewal of term loans and other corporate borrowing instruments are forcing many businesses to assess the adequacy of their funding and increasingly pushing them towards some sort of formal insolvency procedure, whether it be a company voluntary arrangement, administration or liquidation.” He added: “While banks may indicate that they are “open for business”, lending packages, where available, may prove unattractive. Banking covenants will be tighter, with increasing amounts of security demanded (to include debentures over all assets, fixed legal charges on bank deposits and commercial property and also personal guarantees from directors, potentially secured on their own matrimonial homes).” It seems that lenders are unwilling to spend money when they are unsure that valuations have hit rock bottom, which is pushing businesses further towards
Mr Wolff says the SIP16 regulations have done nothing to diminish the attraction of the pre-pack and have, if anything, increased their popularity. He said: “Recent additional regulations for insolvency practitioners on pre-packs, namely SIP 16, have done nothing to reduce their availability and attraction. Arguably, in fact, together with recent case law, they have given tacit approval to the pre-packaged administration sale of a business (even where purchasers are the existing management) and may even have increased its popularity as “the” turnaround tool.”
Chapter 11 regulations – should the UK adopt them? Chapter 11 is similar to the administration procedure in the UK and has the same objective, which is to rescue companies as going concerns or to achieve a better result for the company’s creditors than would be achieved if the company was wound up straightaway (i.e. without going into administration/Chapter 11 first). Damon Watt, from EMW Picton Howell, believes the US system has certain advantages over the UK’s administration procedure that are worth considering. He said: “The emphasis of Chapter 11 is the preservation of the company and the going concern value, to re-organise and re-emerge. Chapter 11, unlike administration, gives a company the ability to re-structure all debt and bind non-accepting creditors. He added: “Administration requires that the company is insolvent; Chapter 11 does not thus providing a company with the flexibility to use the process before becoming hopelessly insolvent. Administration is frequently commenced too late to achieve a beneficial reorganisation of the business. Chapter 11 has been used, for example, to protect companies from creditors where that company has faced disruption caused by industrial action by employees.” Mr Watt also suggests that the Chapter 11 principle of Debtor in Possession (“DIP”), where the existing management retain control of the company, rather than the insolvency practitioner, harnesses the benefits of utilising existing management in specialist areas of commerce which are outside the competence of an insolvency practitioner.
April 2009 Corporate UK 31