“When a business is running out of cash, options are severely limited,” says Grant. “A complication of the pandemic is that many companies have built up significant legacy creditor positions and these will have to be unwound in a controlled manner if any restructuring is to succeed. This all takes time, expertise and the involvement of the right stakeholders.”
“At the moment, very few creditors can take any enforcement action and the extent of the true creditor position for UK businesses is largely unknown,” he continues. “What we do know is that there's money available to support businesses coming out of the other side. But without clarity on how much debt a business has built up during the pandemic, the controlled unwind of this creditor build-up via re-financings, restructurings and other transactions accessing this support is difficult to achieve, which is why timeliness is so important.”
The roadmap back to trading
By way of a recent restructuring example, Grant cites a large nightclub client – The Deltic Group – which was the largest UK national nightclub operator with 52 venues. This sector was one of the first to be closed at the outbreak of the pandemic and it has remained shut throughout. The industry is likely to be one of the last to reopen.
“We were brought in during October when the business was absorbing over £800,000 of cash per month, even after the benefit of furlough, other types of government assistance and the business rates holidays. Due to the business not trading, the company was not paying its landlords either. The company had a cash ‘platform’ until the end of December, so we effectively had three months to work out the best solution and implement it. The complexity of the situation, the group structure and uncertainty around the road map back to a trading environment meant that a company voluntary arrangement (CVA) was not a viable option.”
“We realised very quickly that, with the business running out of cash and no alternative funding available, we had limited time to take this business to market in order to avoid an unplanned insolvency resulting in significant creditor claims and job losses,” he says. “Furthermore, it was critical to ensure any strategy involved the key stakeholders to ensure they played their part in the restructuring, especially the landlords. After all, there were more than 40 landlords who hadn’t been paid for a long time.”
Being transparent with key stakeholders
Of course, business landlords have been impacted significantly by the pandemic too. As a supplier to business, they have experienced the inescapable ricochet effect of lost revenues, and have – understandably – wanted their voices heard too.
“We wanted to have full transparency with the landlord group so involved them very early in the process,” says Grant, “we explained to them that, if we weren't able to sell this business, there would be no alternative but for the business to go into a wind-down administration (possibly liquidation) as there was no funding available to cover rent and other holdings costs. In the absence of any better alternative, we asked them to support the strategy, ensuring landlords received regular updates as the sale process unfolded. We requested a short rent-free period during which any purchaser could negotiate terms of a new lease.”
M&A options for management teams
Most of the landlords agreed to this strategy, which gave BDO more credibility in the market when selling the business. That is where Stuart Deacon came in, another BDO Partner who runs the Special Situations M&A team that works alongside BDO’s Insolvency Practitioner team to find solutions for stressed and distressed businesses.
Historically, the common theme with distressed businesses is that the management team is underperforming. However, this pandemic has impacted previously viable businesses and a key aspect of this case was that the nightclub group was led by a sector-leading management team that was highly investible in its own right. The challenge with such a short lead-time was to get everyone moving in the same direction to achieve a common goal before the business ran out of cash.
Under these types of circumstances, Deacon and his team speak to directors as corporate financiers and not as Insolvency Practitioners. It is a different dynamic that the two BDO Partners are keen to stress. “There is a proper differentiation of duties,” says Deacon. “It is important for the directors to know that we, as a firm, are there to find the best available solution.”
“There is an enormous weight of rescue capital out there, both internationally and in the UK. Often this is described as ‘turnaround’ or ‘special situations’ private equity. We have long-established relationships with these investors, whose entire focus is on these types of situations - and know how to act fast,” he says. “They get excited when the management team is good because they're used to dealing with businesses that have failed because of the management team’s poor decision making.”
Deacon points out that, because the government has provided so much support, and even though there are some high-profile corporate failures, the volume of distressed assets available for turnaround private equity is currently at historically low levels. “What that means is you've got a significant quantum of private equity investor capital trying to find a home in distress situations, and there aren't enough distress situations to go around,” he says.
There’s a second dynamic: a lot of trade operators are geared up to get transactions done too. Deacon points to ASOS and Boohoo as investors in Arcadia. “With Deltic, we found that there was a whole raft of nightclub operators keen to pick up the leading nightclub operator in the UK.” Ultimately, the leading Nordic nightclub operator, REKOM, acquired the UK nightclub chain. REKOM itself is private equity-backed.
“There are a lot of people fighting for deal activity. If we get a large wave of insolvency activity, the situation might flip the other way over time, and we might find that there isn't enough bandwidth and rescue capital out there to be able to deal with the volume of these situations,” says Deacon. “That goes back to Ryan's first point…early engagement is key. The earlier we are involved and looking at the options, the more time we've got to speak to meaningful investors.” Deacon explains further that “bandwidth” relates to investors’ capacity to get the restructuring work done, if that is what is required, to turn the business around. It is not always just about access to capital.
Navigating towards a successful outcome
In Deltic’s case, 1,300 jobs were saved and 42 sites were transitioned across to the purchaser, thereby protecting the majority of the landlords, not to mention the future utilisation of its supply chain.
Grant points out that as businesses emerge from this prolonged lockdown period, they are likely to have a working capital requirement as they re-establish trade and service the unwind of a backlog of creditors. All processes around business restructuring take time and a considerable amount of planning, so a significant number of businesses will probably need to consider the options available as they navigate back to a ‘normalised’ level of trading.
“Those who are going to make the most of this situation are those that address their balance sheets now,” says Grant. “Not every situation is going to require a pre-pack transaction or a CVA, but businesses cannot wait and just assume that their issues will be dealt with.”
“Directors have a really tricky time to navigate, but tricky doesn't mean bad. There could be great opportunities to come from this period as well especially for those that plan ahead.”
Insights Special: Business Rescue
Conversations are intrinsic to business rescue. Be they with a chartered accountant, a bank, HMRC or any other trusteed individual, business restructuring, refinancing and recovery depend upon communication.
