This article was first published in Private Client Adviser
Have you bitten off too much? Unanswerable questions, disgruntled suppliers and unruly board members; John Dickinson offers a guide to investing in a failing business.
There is an old expression that says it is difficult to catch a falling knife. The same could be said of investing in a failing company. Failing businesses don’t normally fail overnight. In most cases, it is the result of a long drawn out process, and there will likely have been at least one round of refinance and a distinct possibility that the business has previously been hawked around for sale. As a consequence there may be a number of stakeholders involved in the decision making, including: the shareholders, directors, financial institutions, landlords, major creditors and the workforce, to name but a few.
Take control with a firm grasp
This is where timing is crucial. In all probability one or more of these stakeholders is likely to compromise their position and without their support you are unlikely to succeed. If there is a history of broken promises and false dawns then they may be less likely to cooperate. Additionally one or more of them may hold security in the form of a floating charge, enabling them to appoint an administrator with minimal or no notice which can quickly scupper any plans you may have. An early engagement with these stakeholders is crucial. However they will undoubtedly prefer solutions, rather than problems, so you may want to have at least the kernel of a plan before making contact. So, taking into consideration the above points, the key to this transaction, as with other transactions, is control. You may not need to have the control, but you need to understand where the balance of power lies. To organise a successful reconstruction, distressed sale, turnaround, call it what you will, the interests of the majority of these stakeholders will require alignment. With all of the reasons above, and others not mentioned, it does not make sense to hold back on making an approach until the last minute in the hope of picking up a last minute bargain. If left too late there may be little or nothing left worth rescuing and you may not have the time to organise matters to enable the integrity of the business to remain intact. As crucial as timing and control are in planning, this starts with your reasoning in purchasing the business. Are you buying it to expand an existing business or merely mass an investment opportunity? In any event, I would always recommend that as far as you are able to “get inside” the business before even considering investing in or purchasing it.. Time will be of the essence and there will be insufficient time to carry out a full due diligence exercise. But you may have time to:
- properly appraise the business
- approach key staff
- have the assets valued
- speak to key customers and suppliers
- plan the first two to three weeks/months trading.
In order to be successful a few useful key points are outlined below:-
Find out as much as you can about the business and the reasons for its failure. You will have been given a reason for the failure of the business but there could be a whole myriad of reasons or issues explaining why they are in this position. Find out about the firm’s key contracts, who the key suppliers are, and identify essential personnel. This will help to create a clear plan on how you are going to turn a failed business into a successful one.
Goodwill is notoriously difficult to value and can largely be discounted as a balance sheet item. However there is another definition of goodwill that will have an impact on the business. Many failing businesses damage relationships, sometimes irreparably, built up over the years of trading. These relationships can be with key suppliers, customers or staff. Attention must be given to these areas and you must identify who controls these relationships and if there was a reason the relationship was damaged.
Don’t assume that the price you are paying is a bargain because of the state of the business. There may be other factors determining the valuation. For example, as referred to earlier, there will be stakeholders who will have expectations. Make sure you know what you are buying and what the real value is. If that requires instructing a professional agent then do so.
Skeletons in the Closet
Be mindful of the liabilities that you may very well be taking on either directly or inadvertently. Most of us will be aware of the obligations that can be attracted in respect of employees’ rights under TUPE. However there may be less visible liabilities that are being assumed, for instance:
- Customer deposits/pre-payments goods may have already been sold, or contracts are part finished and the business has already received the benefit of the payment.
- Suppliers may hold retention of title over goods they have supplied and will look for payment or return of the goods. Or they may require a ransom payment before they recommence supply.
Almost before you start thinking about investing you need to have a notion of your exit strategy. Investing may be the easy part, extracting the cash may be more difficult. If you are buying the business to expand an existing portfolio or business then this may not be an issue. But if it is being purchased purely as an investment then a clear strategy for exit needs to be identified. Whether that is via refinance or a sale to shareholders/management the viability of that proposition needs to be assessed properly otherwise you could be left holding what you may consider to be a valuable but not necessarily desirable asset. When purchasing or investing in the business you should act with purpose and efficiency. Many weeks can be wasted in negotiating issues which become entirely futile, especially if the company enters into insolvency proceedings. Before entering into the negotiations you should have a clear idea as to what your backstop position is and be prepared to walk away if you cannot achieve this. Moreover you should try and complete the deal in as short a timeframe as possible. Boards can often be crippled by indecision and an inability to do a deal could be a sign of things to come. When dealing with the purchase of a business out of a former insolvency procedure most of the above rings true save that very few insolvency practitioners are hamstrung by indecision. Notwithstanding all of the above, providing you take on the challenge with both eyes open and are prepared to give it a lot of your time and make a sizeable investment, not just financially but also emotionally, turning businesses around or rescuing them from failure can be extremely rewarding.
Remember that assumption is the mother of many mistakes. Do not assume that:-
- Waiting around will achieve the best deal
- No-one else is interested
- It will be cheap because it is failing or distressed
- There is only one reason it is in the position it is in
- What you see is what you get
- You have the support of the board
- You will be able to turn it around
- You will be able to get your money out when you want it out.