EN for Business - From Busted to Flush

Venue Finder »

Looking for somewhere to host your event? EN's Venue Finder lets you search by location, capacity and event style, across the best venues in the UK.

Edward De Bono

The word “guru” is one of the most overused in the English language. From PR to plumbing, it seems to be applied to anyone with a big enough mouth and a modicum of achievement to back it up.

More interviews

It took him ten years to write a business plan for the IT firm that was a sideline to his Pharmacy career but both interests eventually led to the deal of his life. Elizabeth Donevan waits for the men in white coats as Ascribe boss Stephen Critchlow reveals...

From Busted to Flush

Tuesday, 29 August 2006

The insolvency process is an uncomfortable fact of business life.

But it is not without its opportunities.

The concept of turnarounds, restructuring or other forms of business remodelling is often difficult for entrepreneurs and management teams to face, because it means they have to acknowledge that something, somewhere within their business hasn’t gone as they’d planned.
Of course, all businesses go through periods where cashflow is beginning to look a bit tight or where they’re desperately chasing unpaid bills, but when this becomes a regular occurrence or when you start to pin your hopes on winning contracts you’ve only got an outside chance of landing, it may be time to pick up the phone to a turnarounds expert.
Wirral-based entrepreneur Nick Owen, who has been drafted in by several banks and investors to sort out struggling businesses, says that managers are often too scared of potential ramifications to have the type of frank discussions needed with funders to affect any meaningful change.

(Photo: Martin O'Neill)
“Quite often, the natural reaction is to try and hide. They let it fester and the situation goes on getting worse and worse, until it reaches the extent where they know that if they flag it up they’ll lose their jobs. So they say nothing until it’s too late and the businesses end up going to the wall,” he says.
This view is reflected by Garry Wilson, a co-founder with Darren Forshaw of the new £100 million northern turnaround fund, Endless. Wilson says that management know better than most when things are going wrong, but they need the gumption to admit problems.
“They shouldn’t be afraid to speak to advisors or funders,” he says. “If they do it early enough, it will give them more options than they probably think they have. There are certain companies we’ve met whom we’d have liked to have invested in, but by the time we spoke to them it was just too late.”

Another reason for a management team to face up to the issue is that it gives them a better chance of maintaining control over the situation. Ideally, this could result in a fairly modest refinancing, with a bank or an asset-based lender agreeing to temporarily extend funds or provisions in order to help a business get back on track.
If the situation is slightly more serious, the directors might want to consider a Company Voluntary Arrangement (CVA). This is a legally-binding measure which basically provides a company facing pressure from creditors with a stay of execution.
Handled by a licensed insolvency practitioner, a CVA allows a company to come to a formal agreement with both preferential and unsecured creditors to pay a reduced amount over a certain period of time. An agreement needs the approval of at least 75 per cent of creditors, but if this is secured, the remainder must accept it.
The advantage of a CVA for management is that it essentially leaves them in control of their own destiny, and as long as they can continue to meet payments, it gives them a much better chance of survival. Creditors, too, are guaranteed the agreed level of payment, whereas if the company was placed into insolvency, they could find themselves at the bottom of a very long queue.
The problem, as Pinsent Masons’ corporate recovery partner Jamie White explains, is that CVAs can take an awfully long of time to organise, reducing a firm’s chances of survival. “Also, while a CVA might alleviate historic debts, these still have to be paid out of any new cashflow generated,” he says. As a result, the failure rates for companies entering into these agreements are high – White says that six out of ten businesses that enter into a Company Voluntary Agreement eventually go bust.
This explains why more businesses are turning to pre-packaged insolvency sales, or ‘pre-packs’ as they’re known. This controversial measure basically allows a management team to agree a deal in advance with an insolvency practitioner to let the company fall briefly into administration, but for the same team to agree a price for the business and assets, which are then transferred to a new company.
The argument for pre-packs is that it offers a company the best possible chance to implement a proper turnaround. The business is freed from its historical liabilities, but a pre-pack allows for a smooth transition, meaning that it can maintain its trading relationship with employees, customers, landlords and other affected parties. It also means that the buyers arranging the deal can sort out the necessary levels of finance in advance. The costs of the insolvency process are also much lower, and for directors it effectively stops the threat of personal liability from trading while the business may be insolvent.
However, pre-packs are not universally popular, and some people within the industry have suggested that it encourages a relationship between company bosses and insolvency practitioners that may be just a little too cosy.
For instance, renowned venture capitalist Jon Moulton recently stated in an industry magazine that the rapid growth in the use of pre-packs had given rise to practices which he described as “unpleasant”.
“The organising administrator has a clear conflict of interest as typically he wants to get the appointment and the management can influence that,” he said. “So a pre-pack is a good idea for practice development for him and the advising lawyers.”
Insolvency practitioners are obliged to take certain steps before agreeing to pre-packaged insolvency deals with management teams. For instance, they have to ensure that the value attributed to the business is a fair one by testing the market in some way (by sounding out a competitor, for instance).
“The administrator is an officer of court and has a duty to the creditors, so they must investigate the alternatives,” advises White. “They need to explore properly the options that are open for a business, because there may have been a trade buyer who was willing to pay more than the management. Independent valuations are critical, to ensure the water has been properly tested.”
However, Moulton says that in practice IPs can come up with many plausible reasons as to why a company can’t be sold to another buyer, or explanations as to why the best price was only likely to have been forthcoming from the directors. The result, he argued, is that pre-packaged deals can often lead to creditors losing out unnecessarily.
“In the real world, you see what look to be abusive practices,” he said. “Pre-packs are carefully planned months or weeks in advance. Potentially, all goods or services acquired thereafter are being acquired with no intention of payment, but rarely do you see companies ceasing to incur credit for a period before a pre-pack – in one recent case, it seems the directors actually sought to maximise creditors ahead of a pre-pack by doubling regular orders.”
There is another argument against pre-packs, and it is one with which many entrepreneurs would concur – that the people who dragged down the business in the first place are simply not fit to run it, and wiping the slate clean represents a triumph of optimism over experience.
When Owen was drafted into Oldham-based engineering business A Andrews, for example, he says it was clear from the outset that its management was the main problem. Venture capitalist 3i had backed an MBI team a couple of years previously but instead of growing the business’s £4 million turnover and increasing itsmargins, the MD had managed to let the former stagnate while the latter simply disappeared.
“He was not performing and he just got to the stage where he didn’t know what to do – he was like a sheep staring at a car in its headlights. Staff and customers were both leaving in droves and morale was awful,” he explains. Owen was confident that he could turn the business around with a cash injection from its backers, and he negotiated a 27.5 per cent stake to do so, which would climb to 40 per cent if it met some incredibly tough performance targets.
“I had my tongue firmly in my cheek when I suggested them,” he laughs. Still, within five years he had rebuilt the business on a philosophy of ‘loving the customer’ which meant that although it wasn’t necessarily the cheapest operator in a highly competitive field, it was one for which customers were willing to pay. By the time the business was sold to BSS in December it was making profits of £2.1 million on an £18 million turnover, and Owen got his 40 per cent of a £14 million sale.
Owen’s tale reveals one of the reasons as to why many entrepreneurs are attracted to the company doctor/turnaround role. Although risky – reputations can be destroyed with a single deal – they also offer potentially significant rewards and in many cases expectations for improvements couldn’t be lower.
This was the case when Bill Gleave was inadvertently thrown into his first turnarounds role after selling his Burnley-based firm, Northern Textiles, to Wythenshawe-based plc French Group.

He stayed on to run Northern Textiles, and within two years he was being asked to bail out its ailing parent, which was on the verge of insolvency and in danger of breaching its banking covenants. He renegotiated the equity split with its backers, allowing him to bring in a new team of investors including BMI chairman Sir Michael Bishop and Richer Sounds founder Julian Richer, as well as former Asda boss Archie Norman as his chairman. “I fixed it first, and once the value was there, I asked the investors what they wanted from it. I knew I could return the cash much quicker than use it as a vehicle for growth, so that’s what we did.”
His latest challenge is the turnaround of the former Bernstein Group, a kitchens and furniture distributor based in Westhoughton now known as BGH. The company, which employs 400 people, was placed into administration in December 2004 after losing a contract with its then biggest customer, B&Q.
Gleave says he had no hesitation in launching a buy-in, management buy-out of the company, which was completed a month later. Although its previous management had been commercially naïve in relying on the DIY retail giant for business (80 per cent of its sales were to B&Q) they had invested more than £25 million in manufacturing and developed a first-class logistics network.
Gleave’s strategy has simply been to diversify its customer base – targeting builders’ merchants, housebuilders and a social housing sector that is pouring millions into home improvements in a bid to meet the Government’s Decent Homes standard. It has worked a treat, with sales growing by around 35-40 per cent since he took charge.
He says the three most important things to consider in a turnaround situation are cash, cash and cash. “Usually, the supply chain will have been spanked so the level of credit that’s going to be offered you will be very low,” he explains. “ In the early stages the focus is on trading rather than profit, and you have to concentrate on taking costs out wherever you can.”
Forshaw explains that this is one of the reasons that Endless will always add to a management team when investing in a turnaround. Sometimes, management teams that have been under pressure to cut costs for a while develop a siege mentality. “They get tired of fighting the fight,” he says.
“One of the businesses we’re currently working with had a management team that was adamant no further costs could be taken out, but as soon as you change the finance director, the new guy coming in sees the business in a different light,” he says.
The warning message is clear – if an entrepreneur proves to be unwilling to face up to the problems a business is facing, the likelihood is that a funder will eventually find someone else to do it.