UK: Restructuring & Recovery Quarterly Bulletin: Negotiating The Storm - Spring 2013

Last Updated: 11 April 2013
Article by Liam Dowdall, Panos Papas, Kevin Parish and Neil Hickling

KEEPING BUSINESSES AFLOAT

By Liam Dowdall

A clear strategy and good advice are needed to turn around a business under pressure, says Liam Dowdall of our Dublin team.

Each day we read of companies going into receivership or liquidation in the economic downturn. Despite the difficult economic climate, there are clear actions that businesses can take to stay afloat and ride out the current recession. Over the past few years, our restructuring and recovery team has assisted many businesses to stay afloat. The key to any successful financial restructuring is for businesses to engage at an early stage in the process before the problems become insurmountable.

The corporate health of a business and the available recovery options over the course of time are inextricably linked. Early, decisive action is crucial for a successful turnaround. If early warning signs are not heeded, knock-on consequences can include balance sheet/profit decline, cashflow issues and ultimately failure.

Key to a successful turnaround

The key to a successful turnaround is for management to recognise that they have a problem and that they need to take independent and objective advice.

Companies with financial difficulties will exhibit difficulties in some or all of the following areas: the management team, relationship(s) with lenders, creditors and financial issues.

Address short-term working capital issues

Businesses do not fail because of short-term lack of profitability – they fail because they run out of cash. It is critical in any business turnaround to manage short-term funding requirements. Headroom is needed to allow the business to continue to meet creditor payments while it carries out its financial restructuring.

Key areas to be addressed during this phase are as follows.

  • Strengthen credit management procedures.
  • Communicate and engage with lenders to keep them on board.
  • Arrange suitable phasing of supplier payments including Revenue.
  • Seek additional equity investment from shareholders or connected parties.
  • Sale of non-core assets (including stock) to generate cash
  • Prepare comprehensive cashflow forecasts.

Consideration should be given to all alternative sources of working capital such as asset-based finance e.g. invoice discounting or stock finance.

As overdraft finance in Ireland has become harder for businesses to secure, asset-based finance such as invoice discounting is becoming more popular. Asset-based finance is predicted to grow by 9% in the UK and Ireland in 2013. Turnover for companies using asset-based finance is predicted to grow by 12% in 2013 in the UK and Ireland.

Finance can also be raised where there is unencumbered plant to provide additional working capital in the short-term.

Operational restructuring

After the initial phase of the restructuring plan, the next step is to work with management to carry out an operational restructuring of the business so as to create a suitable environment in which the business can successfully go forward.

Areas which we would advise on during this phase are as follows.

  • The strategic options available to the business to ensure its survival.
  • Assistance in the preparation and implementation of a comprehensive plan.
  • Assistance in the sale or wind-down of distressed or noncore segments of the business.
  • Liaising with creditors (including Revenue) and their advisers.
  • Negotiation with company lenders and possibly seeking alternative sources of finance.

Appoint interim management

As part of a turnaround strategy, the stakeholders/ management should consider the appointment of an interim manager where they see a management team deficit and where individuals with relevant expertise and skillsets can come on board. This approach has worked successfully in the retail and hospitality sectors in Ireland in the last number of years.

Way forward

When companies get into financial difficulties doing nothing is not an option. It is important for stakeholders and management to maintain communications with creditors, bankers and indeed employees during this time. A turnaround manager can give confidence to lenders, creditors and management that the challenges faced in the business are being addressed in a meaningful way.

INDEPENDENT BUSINESS REVIEWS (IBRs)

By Panos Papas

Not just for banks, IBRs can be a valuable way of assessing risks to your business in time.

People generally think IBRs are carried out for banks. While that is true, I have carried out IBRs for all types of stakeholders, including shareholders, trade creditors, pension fund trustees, and significantly directors of the company itself.

What is involved?

Stakeholders often ask us to advise them on what action they should take, for example based on a set of forecasts they have received from management showing that the cash needed in the business exceeds the current facility limit. In other cases, we have been called in when the business is suffering and already trading beyond its overdraft limit. Typically we would:

  • meet management as soon as possible, asking for example what has gone wrong, what has gone well and also listening to what plans they have for the business's future.
  • look at financial forecasts generally prepared by management or their own accountants, and then reviewed during the IBR. If management prefer, we can produce an integrated spreadsheet model based on management's forecast assumptions to show monthly profit and loss, cash flow and balance sheet the coming 12 months for example.
  • look at turnover, gross margin and overheads. These are often key factors in determining how well a business is performing, and we seek to understand reasons for any shifts in these both historically and in the forecast figures.

It is important that any key changes in performance between the forecast and historic results are investigated thoroughly and credible reasons are given, particularly for any significant upturns in profit. For example, we recently built a model for a business showing the continuation of a trend of falling sales income, which management considered was the most likely scenario. This unfortunately showed the business needing far more cash than its existing lenders were prepared to make available. In our discussions with management, we impressed upon them that the way forward was not to change the forecast assumptions to close the funding gap, but to recognise that it was coming and to take action straight away.

It is important to also look at the company's existing balance sheet and current liquidity, to understand the cash dynamics of the business, and again to check that any changes in assumptions can be supported.We also run sensitivity analysis – 'what if' scenarios to show the effect on cash flow and profit if management's forecasts are not achieved. This can throw up some unusual results. For example, a business we looked at in the construction industry was paying labour costs weekly but was only paid by contractors after 60 days. As we ran a number of scenarios showing what would happen if turnover went up, we found the forecast cash needed in the business also increased considerably.

The business review - an opportunity

Management are often concerned that the business review is a precursor to insolvency. We see the review as an opportunity to assist with identifying ways that a business can be turned around, and we may be able to suggest more appropriate types of funding.

We will always work closely with management and ensure that they are kept informed as to timescales for delivery of our report. Generally we will discuss a draft of our report with management before issuing it in final form, thus avoiding any disagreement on the facts.

Concluding the review

Stakeholders need clear advice – depending on the agreed scope, our review will conclude with a summary of the options available for both the business and the stakeholders and our recommendations on how to minimise their risk by taking decisive action. This can be achieved through a number of different solutions.

Following some recent IBRs we have:

  • introduced management to new investors interested in supporting the business through a difficult trading period.
  • negotiated a time to pay arrangement with HM Revenue and Customs, thereby gaining a breathing space for the business.
  • suggested areas where the business can make improvements, for example to its cost structure, or management team. We may also be engaged more formally in this context to carry out a full business turnaround review.
  • in a case where the business was unsustainable, completed a distressed sale of the business as a pre-packaged administration. Our corporate finance colleagues assisted in the sale and the business is now trading profitably under new ownership, the lenders being repaid in full.

In current circumstances, stakeholders and management need to be more aware of the risks to businesses which continue to operate when underperforming, or where they risk running out of cash. A business review will highlight these risks and offer clear advice as to available options for all parties.

FOCUSING ON NON-FINANCIAL OPERATIONS

By Kevin Parish

Improving non-financial operations can help you get ahead in creating space for change.

There has never been a time when it has been more important for businesses to operate efficiently. At the moment, many businesses will rightly be focusing their attention on winning their next sale or contract, and maintaining or increasing their market share through innovation or better marketing. This is occurring at a time when margins are under pressure in many industries and where some markets are reducing in size. Other businesses, particularly those in sectors where there has been contraction (such as retail and leisure), may also be looking at cost-cutting measures to improve their financial position.

Optimising, monitoring

Few businesses, particularly hard pushed owner managed businesses, will have the resource and skills internally to turn their attention to their business processes as a source of enhanced business performance. Some will have looked at matters such as internal controls and segregation of duties (particularly if their auditors adopt a risk and systems based approach) but once you step away from the accounting function the same attention is rarer, even in some process-led businesses. Optimising and monitoring those tasks that are not purely financial but which are, instead, driving the delivery of the product or service can bring substantial gains.

In many companies the processes, workflows and management information have largely evolved over time, with the requirements of different departments being introduced and changed as and when individuals and circumstances dictate but without a joined-up approach. These disparate sources of influence often create not only conflicts but gaps in management information and responsibility and with limited exceptions, the processes are generally not documented and visible to middle and senior management.

There are a number of key areas where review and enhancement of non-financial business processes can bring rewards.

  • Operating efficiencies – leading in turn to enhanced competitiveness and improved financial performance.
  • Improved management information, facilitating decision making and performance management.
  • Risk reduction.
  • Staff morale (although this can be a double-edged sword) by improving their experiences in the workplace.

Reducing the benefits of process down to a relatively simple level, imagine for a moment the difference between you laying a path in your back garden and entrusting the job to an experienced landscaper. You may be able to produce the path to the same quality and have developed a plan to do it but I can almost guarantee that it would take you longer. Experience is a factor but the landscaper will (hopefully) arrive with a process in mind for your job and some carefully chosen tools to do it with. Extending this example further, if one landscaper has a tipper truck and can tip all the sand and gravel they need straight into a location on the site that is convenient and their competitor has to spend two hours moving it from a bag left at the roadside, there is a difference in process and one is likely to be substantially more efficient than the other. If, in order to win the work, both landscapers price the job at the same level, then one should not only make more profit but be finished sooner and ready to move on to the next job.

Mind the gap

The consequences of a failure or gap in business process can be catastrophic. In the context of a professional practice, a failure to, for example, identify a client and to obtain signed engagement terms that encompass all of the advice given could lead to a regulatory issue for having failed to properly undertake 'know your client' procedures, which could (in a worst case scenario) have criminal repercussions. This first point would also lead to potential loss if the client couldn't be located when it was time for them to pay their bill.

In the event of a payment dispute the absence of an engagement letter convincing the court that the client should pay a disputed bill would be more difficult and even worse in the event of a professional indemnity claim. There could be difficulties in defending the claim and with the practice's insurer.

Professional practices and financial institutions will generally have a good understanding of these mission critical procedures, backed up by checklists and clear lines of responsibility. Other less compliance-led businesses are far less likely to.

Recent experiences

We have recently worked with businesses to help them optimise their operations outside of a formal restructuring process. An outsider's perspective is valuable for this type of exercise for far more than just providing a dispassionate and fresh view of the existing processes. We have found that acting as an external consultant can allow us to obtain a greater level of disclosure from front-line staff as to the shortcomings of existing systems and their concerns when their comments are largely anonymous.

A recent assignment saw us assist management in identifying, planning for and implementing significant changes to their entire operations over a period of just a few weeks including:

  • changing the timing of a number of business critical functions
  • altering internal documentation
  • introducing new controls and management reporting
  • putting systems in place to automate data validation and checking using existing software
  • changing working practices and job roles
  • restructuring the management team
  • introducing KPI's and core standards.

The ultimate goal of reviewing any aspect of a business is to enhance stakeholder value. An operational review, with the full buy-in and support of management and the assistance of someone independent with the right skills can reap substantial financial and non-financial rewards. The process itself can be done progressively over time or through an intensive period of activity where fundamental change is required as part of a restructuring or turnaround plan. The critical thing is to start before the business reaches a crisis point and while it still has the resources to implement change.

INTERESTING BITS AND TRENDS IN PERSONAL INSOLVENCY - THE RISE OF BANKRUPTCY TOURISM IN RECENT YEARS

By Neil Hickling

An interesting development over the last four years has been the growth of bankruptcy tourism with a number of people, often with a high profile, filing their petitions in England where there is a one year automatic discharge period compared to currently five to 12 years in Ireland and seven years in Germany. These countries are where we are seeing the most growth in bankruptcy tourism. The deciding factor is the COMI (Centre of Main Interest) of the individual and should correspond to "the place where the debtor conducts the administration of his or her interests on a regular basis and is therefore ascertainable by third parties". Four years ago, it was relatively easy for insolvent individuals to come over from Ireland or the continent and satisfy the court that his or her COMI was in England, file their petition and take advantage of the perceived more lenient process. However that has all changed with various high profile Bankruptcy Orders being annulled (Sean Quinn, Dr Eichler, etc) and the court's view such similar applications with a more critical eye. One of the most recent cases to go through the courts, that of Sparkasse Holden Velbert v Benk (yes that old favourite) has resulted in various tests which are applied in establishing the debtor's COMI as follows.

  • Where is his or her normal permanent home where contact can be made?
  • Where is the professional address (if applicable) and from which address does the individual administer their affairs?

The court will also require the COMI to have an element of permanence and the debtor can have only one COMI even though it can be relocated at any time prior to them filing their own petition.

In the Benk case referred to above, the court considered that a lot of the evidence produced by the debtor amounted to window dressing and ultimately annulled the bankruptcy order made earlier. As a result of the Benk case, it is likely that the pipeline of bankruptcy tourists from the Continent and Ireland is likely to decrease. In addition, Ireland has a new Personal Insolvency Bill introduced earlier in the year which will be enacted in April 2013. The legislation is radically designed to overhaul the law on bankruptcy and personal insolvency. Among other things, it will reduce the length of bankruptcies to three years.

Again this new law is likely to have the effect of reducing Irish bankruptcy tourism. As a matter of interest, I have always believed that the English discharge period was too short. I remember the time of the Bankruptcy Act 1914 (some people might think I was around to help frame the legislation but no, it's not true) when there was no such thing as automatic discharge and the onus was on the bankrupt himself to apply to the court; a relatively rare experience! Interestingly a recent survey by our professional body R3 established that 58% of the population believed that bankruptcy should last longer than a year. My view is that reform will take place and we are likely to revert to a three year discharge period within the next five years.

I think that is enough from me. I suppose my last point is how life has changed for an insolvency practitioner out in the leafy shires over the last 30 years or so. In the 1980s, the only international bankruptcy I dealt with was the odd Welsh sheep farmer with the odd Welsh sheep. Nowadays, I am regularly realising properties in Bulgaria, South Africa and the United States, yachts in Majorca and vehicles in Spain. Next month I am off to court in Cyprus as a witness where hopefully I will be successful and repatriate funds for creditors in one of the bankruptcies I am administering as trustee.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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