1. Cash Control is Key

• Make sure you are aware of all aspects of your current financial position. Sticking your head in the sand and hoping it will all fix itself is never going to be constructive.
• Budget, forecast and review frequently; the sooner you know something is not quite right, the sooner you can take corrective action and minimise the harm to your business.
• Ensure you have an effective credit control process which closely manages debtors and receivables. Remember that you can always renegotiate credit terms if necessary.

2. Proper Preparation Prevents Poor Performance

• Research your market thoroughly so you know your place in relation to your competitors, pricing, marketing and objectives.
• Plan both short-term and long-term achievable objectives. Remember to monitor your progress in relation to your plan, updating it if necessary and providing feedback to staff and other stakeholders if appropriate.
• Think to the future and ensure that any retention of title clauses in your terms of trading are sufficiently drafted to secure your proprietary interest and protect yourself if a debtor becomes insolvent. 

3. Think Outside the Box

• In uncertain times the rules have to be adapted to achieve the best results and slightly less conventional methods of raising finance, such as asset-based lending, may offer viable solutions. Ensure you’ve considered all the options and evaluate which best suits your goals.
• It’s very easy to get caught up thinking about the welfare and activities of your own company but don’t forget to consider the wider environment and potential risks from external sources such as suppliers.

4. Be Proactive 

• If your cash flow becomes problematic, speak to creditors early and try and initiate informalarrangements to defer payment temporarily.
• If a debtor enters insolvency proceedings, make a claim as soon as possible and inform the appointed insolvency practitioner so that you are kept informed and can participate in the process where possible.
• If you think you’re at risk of becoming insolvent, contact an insolvency practitioner as soon as possible so you can take advice on saving the business, minimising liabilities and maximising returns to creditors.

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Pre-pack administrations, where the business of an insolvent company is sold as soon as the administrators are appointed, often to the company's management or shareholders, are under scrutiny.

• The Business and Enterprise Select Committee (Chairman - Peter Luff MP) examined the issue when Stephen Speed, the head of the government's Insolvency Service, appeared to be questioned on 27 January (video here - see 38mins 50secs).
• BBC Radio 4's File on Four recently illustrated creditors' concerns about companies in the printing and retail industries where pre-packs had occurred (transcript here).
• BBC 2's Newsnight is shortly also to explore the sales of assets to failed companies' directors or their associates through pre-pack administrations.
• Press articles frequently refer to the effect of insolvencies on creditors and report surprise that businesses can be allowed apparently to continue after dumping creditors.

Two separate issues should not be confused.

Firstly, creditors suffer financial loss in an insolvency because the company has failed. The pain may feel worse if the management thought to be responsible for the loss appears somehow to benefit. But the fact remains that it is the company failure that causes the loss.

Secondly, insolvency procedures operate in the interests of creditors. Of course they must work properly to produce the best result, but that is why insolvency practitioners are highly trained, licensed, strictly regulated and, as officers of the courts, obliged to act properly. Insolvency is a complex process where a highly specialised area of law confronts commercial reality. Explanation is therefore crucial and the regulators emphasise transparency, for example in Statement of Insolvency Practice ("SIP") 16  "Pre-packaged Sales in Administrations", which came into effect for adminstrators appointed after 1 January 2009.

Until the recession, few people in business felt the need to think about insolvency, but understanding the insolvency process and its safeguards may help creditors appreciate that the procedures and the practitioners really do act in the interests of the creditors.

How can it be right that the directors appoint the administrator to sell the assets back to them?

The administrator acts for and has his remuneration fixed by the creditors. Of course he may have been introduced by the directors, but they have a legal obligation to call in an insolvency practitioner as soon as it becomes necessary.

Why were the assets sold so cheaply?

The administrator's job is to get the best result for the creditors (if the company can't be saved). One of his skills is selling distressed businesses and assets. Sometimes there may have been no obvious marketing, in which case the administrator will have commissioned an independent valuation and taken specialist professional advice to get the best deal.

At the time of the pre-pack sale (or shortly afterwards when they find out about it), creditors may not know enough about the precise circumstances to make a fully informed judgement, which is why the administrator is required by SIP 16 to explain the sale to creditors as soon as practicable. Ideally they should learn about it from the administrator immediately, with a full explanation so that even if not pleased about their losses, they are at least satisfied that the insolvency procedure is achieving the best recovery.

What if I'm not convinced it was the best deal?

Remember that it must be the best result for all creditors, including some who may have different interests; but, if you're not satisfied, engage in the process.

Talk to the administrator - if you know something he doesn't, he'll want to hear from you.

Raise your concerns at the creditors' meeting - other creditors may share your views or could have a different perspective.

To be involved in monitoring the administration and assisting the administrator to get the best result for creditors, get yourself elected onto the creditors' committee, but be aware that your duties there will be to act in the interests of all creditors rather than just yourself or an interest group.

It may be possible to nominate another insolvency practitioner to be liquidator once the administration ends, for an independent professional review of the administration. If not, and you still have concerns, you should consider seeking specific advice from an insolvency practitioner or insolvency lawyer on other remedies such as applying to court.

If you think the administrator has done something wrong you may want to complain to his regulator (the administrator has to tell you who that is - there are several), but that is more likely to lead to sanctions against the administrator than to things being put right in your particular case.

Why should the directors get away with it?

Buying a business from an administrator isn't itself a bad thing. But if you know of impropriety that went on before the administration, tell the administrator. He can then take any necessary action for the benefit of the creditors.

Are pre-packs a good thing?

Independent research into pre-packs by Dr Sandra Frisby of Nottingham University has established that in over 90% of pre-packs all the jobs in the business are saved, compared to only about 60% in other insolvency business sales.

There is no evidence that returns to unsecured creditors are better in pre-packs than in those administrations where the administrator secures funding to allow the company to continue to trade for a period while he markets and sells the business. Pre-packs can, however, reduce the risk of value destruction as a result of the insolvency process; they often realise more than simple liquidation; and they almost invariably cost less than a period of trading followed by a business sale.

The crucial point though is that in any particular case, the insolvency practitioner has to get the best result for the creditors as a whole. There is no evidence that this is not happening in the vast majority of cases. If the administrator has chosen to use a pre-pack it is because he believes that it is in the best interests of the creditors as a whole that he should do so.

Once the administrator has been appointed, the creditors' money has already been lost; and if the alternative is worse, using a pre-pack is undoubtedly a good thing.

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While the recession will undoubtedly hurt a good many people, those (albeit relatively few) private investors and buyers of businesses who have ready cash to invest stand to make handsome profits as they take advantage of increased opportunities to buy 'undervalued' businesses.

For them, choices as to which investment to make, how to make that investment, and timing will be key. Of these three key decisions, the 'how' requires closest professional support, and this article considers some of the issues shrewd investors should consider.

Buying an insolvent business is very different from buying a solvent one

• Insolvent and unprofitable businesses often have significant hidden costs that can come back, often several years later, to haunt the buyer. The list of such potential costs is long, but typically includes unrecorded customer disputes; underutilised assets to which excessive liabilities are attached; unprofitable products or services where there are significant discontinuation costs; unrecognised tax liabilities, such as on misreported director drawings; and contingent exposure under property leases. The full list goes on and on!
• Investors are generally unable to call on indemnities for such costs from the owners or management of the business or any insolvency practitioner dealing with the company.
• Restoring a business to profitability often has significant cost implications. If it didn't, the current owners of the business would probably have already done it.

This means that buyers of, or investors in, insolvent businesses should: 

Assess the level of risk in their investment

It is essential that a thorough due diligence is done, whichever acquisition route is followed - Investors truly have to fully understand the business, not just the potential for greater upsides but also the potential for significant downsides. Investors should not rely on assurances or warranties given by the directors or owners of the business - it is in their interests to say what they think the investor wants to hear in order to get the deal through. In practice directors almost always understate the issues investors may have with the business.
 

Make sure that the risk involved is reflected in the price paid and in the way that the purchase is structured

Investors should always allow themselves some considerable margin for error - in practice nothing works out as well as they would hope when it comes to buying an underperforming business. As the issue of of the structure of the deal is so important, the remainder of this article will focus on some of the key issues we see time and time again.

Structure of the investment

Ask yourself these questions:

1. Should I be buying the shares in the company or the business and assets?

There is nothing to stop investors buying the shares of an insolvent company, the investor will simply have to restore it to solvency by pumping more cash in, typically by increasing the share capital. However the main drawback to any such 'share deal' is that not only does the investor take on the known insolvent position of the business and thus all of its recorded debts, they also take on any unrecorded and unascertained debts. At the time of the deal most investors simply have no real idea what hidden liabilities may or may not lie in the business.

If a business and asset purchase is the route to be taken, the investor takes on only those liabilities that they agree to take on or by law have to take on. It is not unusual for a purchaser to take on debts owed to key suppliers in order to maintain important trading relationships. Other liabilities, such as certain employee liabilities under TUPE, cannot be avoided by law: the investor has to take them on. Such a 'business and asset deal' can give the investor more certainty as to what they are taking on than a share deal - but this is no reason to limit the due diligence exercise, investors should still search out potential liabilities they may be forced to take on at a later date for commercial if not legal reasons.

There can sometimes be advantages to buying the company's shares. For example there is a much easier transition to the new management - all pre-existing contracts, such as with suppliers, customers, finance companies, etc remain in place. Yet again, investors should review all such contracts as part of their due diligence, as some may contain termination provisions, or require pre-existing guarantees to be replaced should there be a change of ownership. Again, it is a case of the investor understanding exactly what they are taking on.

Serial investors often have a model route for buying into businesses. These models do not always fit the specific circumstances of the target business: it is important that both sides recognise that fit is important.

2. Do I really want all of the business?

Often purchasers want to cherry pick, taking the best bits of the business while leaving someone else, either the existing management or an insolvency practitioner, to clear up the parts they do not want.

There are several issues here. Leaving the clearing up of the unwanted remnants of the business can be a diversion of precious management time post acquisition. Management have difficulty valuing the 'best bits' and often wish to distance themselves from the sale process in order to avoid any accusations of having somehow benefited unfairly from the sale - management may prefer the deal to be completed by an insolvency practitioner because he, unlike the directors, has no long term interest in the outcome, and he will, in employing his own valuer to value the business, be able better to explain the rationale for the deal to suppliers and other creditors. Completing a sale through an insolvency practitioner can not only protect the directors from criticism that in some way they failed to comply with their duties, including those under the Insolvency Act 1986 and Companies Act 2006, but can also simplify the overall scheme. And, as you will see later on in this article, it can also save the investor money.

3. Should I defer some or all of the purchase consideration?

Deferring part of the price paid, particularly if the sum is dependent on trading results achieved post acquisition, will reduces investors' risk. As typically vendors look to maximise what they receive in certain cash on day one, the vendor's and purchaser's preferred outcomes can be poles apart.

Another option is to introduce cash into the business on a secured basis, rather than as share capital or unsecured loan. There are several implications of this should the company go into formal insolvency sometime later on: make sure that you discuss your options with the appropriate professionals beforehand.

If the business is insolvent and in need of a cash injection, the investor is often helping the vendor 'avoid' potential exposure to the bank under personal guarantees. Most investors like to see some input from the vendor post acquisition if only in making introductions to customers and suppliers. Under these circumstances, it is not unreasonable for you to defer some, if not much, of the purchase price as arguably the shares have little or no value at the time when you release your cash and deferring payment will secure the vendor's cooperation.

4. Have I explored the tax consequences?

If an investor buys the shares in the company and it has tax losses, the losses can be used going forward, against profits of the same business. If the assets are bought instead, the benefit of such tax losses are often lost.

Take advice from a tax specialist as this is very much a simplification of a much more complicated situation.

5. What are the true costs of this purchase?

Putting the company into a formal insolvency process and buying the business and assets from an insolvency practitioner can enable potential investors to reduce the working capital requirement of the business and thus the amount of cash they need to invest. In the right circumstances a 'Pre-pack', where the insolvency practitioner completes a sale of the business and assets immediately after his appointment, may be the best way to put the business on a soundest possible footing going forward, but here too there are further issues, with pre-packs coming under ever greater scrutiny.

Stop, think and plan

In summary, shrewd investors considering buying an underperforming or insolvent business, will stop, think, and then re-assess exactly what they intend doing and how before committing. That way they will maximise the profits from, and reduce their risk on, the increasing number of opportunities they will surely get as the Recession bites deeper.

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Here's a view on the UK's economic outlook from Howard Reed, Chief Economist at the Institute for Public Policy Research, published in the New Statesman: Was Northern Rock the worst of it?

Despite huge stock market falls in the last two days, the balance of comment still appears to be that the underlying UK economy is in reasonable shape and whilst we can expect further tightening a recession is not on the cards.

Reports following analysis of January's Monetary Policy Committee minutes at Bloomberg and Channel 4 News illustrate current thinking (although the latter notes that George Soros, billionaire investor, disagrees. . . ).

No recession, I agree, but we certainly haven't seen the worst of the turbulence. In the business world I think there are many who have not yet come to terms with either the dramatic change in lenders' appetites or the effect the turbulence has had on consumer sentiment.

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