Buying failed businesses
With companies going bust left, right and centre, Growing Business investigates buying businesses in a downturn
Companies are going bust left, right and centre as recession squeezes the UK economy. The administrators are busy, but on the upside there are bargain-priced assets to be claimed.
For many owner-managers, growth strategies have been replaced by survival plans. Now is not the time to be considering acquisitions, they say, but rather for battening down the hatches. For others, the dark clouds of recession have silver linings: lower costs, struggling competitors and a new order that might leave them at the top. The chance to buy a failing business at a good price is always worth a look, but it takes nerves of steel, and cash. Buy-ups are risky, even in boomtimes, and many have been burned in the process before.
Cast aside any feelings of guilt. It's a fact of life that downturns produce winners and losers. Feeding on those who have fallen is normal practice in a market economy, and essential for its eventual recovery. You've already seen the headlines and know that there's carnage on the High Street, and this is reflected in the wider economy.
Insolvency figures in the third quarter of 2008 reveal 4,001 compulsory and voluntary liquidations in England and Wales. This was an increase of 10.5% on the previous quarter and 26.3% on the same period a year ago. Figures for the final quarter and first three months of 2009 are expected to show more decline and the end is not yet in sight – not unless you believe what the government says.
Colin Haig works as an administrator at PricewaterhouseCoopers and says his workload has massively increased recently. Previously, businesses would be referred to him before they hit truly dire straits, when creditors were beginning to have concerns. This gave him the time to market the struggling firms and find buyers to rescue them. However, the average time between referrals and outright insolvency has been reduced, mainly through a lack of credit.
“There are some really good companies, but they have just been over-leveraged. I have seen businesses that would have needed to have been working at their optimum potential if they were to have had any chance of servicing their debt,” he says.
For those with the cash, guts and strong advisers, there's nothing wrong with buying from an administrator. You might understandably be suspicious of a failed company, but the credit crisis is so severe that there are some businesses that should, by all rights, be up and running, and entrepreneurs should be encouraged to resuscitate them.
Matthew Riley, founder of business telecoms company Daisy Communications, has made close to 20 acquisitions since founding his business in 2001. Previously, he would buy up the accounts and lists of competitors that were going concerns. However, he now has his eye on failing businesses. “There are a lot of assets around and there are some companies in distress, so there are going to be a lot of bargains about,” he says. “If you are a strong company with a good track record, then you can take advantage of that.”
But be warned, there are dangers to buying a company in distress, and it's essential to understand what the real cost of buying is. There's often a good reason why a company has gone bust and it isn't always the fault of the banks or the availability of credit. It's essential to ensure you have some good advisers with experience in the field beside you. “You can bet that whoever you are buying from won't be selling for the first time. Don't scrimp on your advisers, as that's a false economy,” advises Haig.
No trade sale
Buying from an administrator does bear some similarities to buying from another business. For example, you need to understand why you are buying and how it fits into your overall plan. However, the speed of the deal is likely to be much faster and you aren't going to be able to get the same level of information or assurances that you would from a trade sale.
“If the vendor is an owner-manager, there is a pressure on them to be very forthcoming with information about the business, as there will be warranties attached to the deal, which could reduce the overall price if they are breached,” explains Irit Edri, a solicitor at Keystone Law who specialises in company administrations. “However, when buying from an administrator, it's unlikely they will provide such warranties and will provide far less information.”
You must remember that administrators are there to get value for the shareholders or the secured creditors of the business (depending on the deal) and aren't motivated to be concerned about what happens after the deal. The relationship between the two parties is, therefore, very different to a trade sale or even a private equity deal. Typically, the administrator wants to get as much cash as possible and then get out. This can result in some deals turning into something of a lottery for the buyers, so you should mitigate your risks (see Avoid the Pitfalls on page 39) and consider the worst-case scenario before taking the plunge.
A bit of detective work is always a good idea when buying a company. Countless entrepreneurs recall how the ‘guy on the shop floor' had answers to crucial questions. Acquisitions are a risk and arguably you never really know what you have until you've bought it, but the more information the better.
One of the main reasons why an acquisition fails is that, when it comes to integrating the business, not enough planning has been done. Richard Horsman, chief executive of telematics service provider Cybit, has bought several businesses, including some based overseas. For him, the most effective due diligence is done by talking to existing employees and bringing them on side.
“The key is to get buy-in from the people and get them to help you. I don't do hostile takeovers. If you spend time with people, they will tell you where the problems are, as long you ask them in the right way.”
Where you are buying from an administrator, prior knowledge of the business is even more important. Edri explains that many entrepreneurs who do this have knowledge beyond that which is contained within the Information Memorandum.
“Often, when entrepreneurs buy companies out of administration, they know the business well beforehand,” she says. “Either they are competitors or have associations with the company in some way, or they are directors buying back their own business.”
Indeed, in some cases a buyer is found and a price agreed before the company is placed into administration. These are known as pre-pack administrations, and carry the added advantage to the buyer that the company purchased will be free of debt.
Tracking down the right company to buy isn't easy, but there are a number of routes to take. Keep your ear to the ground over the next few months to make sure that a sensible buy doesn't land with one of your competitors. Now isn't an easy time to do business and some will be only too pleased to get out of the game. If you are known as an acquiring business then some will want to come to you. If not, consider employing a corporate adviser who will identify targets, compile information and approach them on your behalf.
The problem with distressed businesses is that they aren't always easy to find. Administrators inform The London Gazette of their appointment, but by the time you read about it there's a chance the company will have been sold. A new website worth a look is www.ip-bid.com, which is free for entrepreneurs that register and provides details of recent administrations from insolvency practitioners. There are also other online databases, such as www.business-sale.com, that provide information for a fee. Then there is your own trade press and the business pages of newspapers.
Should you buy?
Acquisitions are always risky. Whether in a downturn or a boomtime, or if you're buying a company in distress or a going concern, common sense rules apply. The first place to start is where you are and how you sit within your industry. If your finances and management team are up to the job and there are opportunities for consolidation, this is far more important than the state of economy. Huw Davies is the founder and chief executive of Boomerang Plus, an AIM-listed TV production company, which focuses on projects outside Greater London. His market position is boosted by recent legislation that has strengthened the hand of production companies with regards to intellectual property, as well as quotas that demand that recipients of the licence fee buy programmes from outside London and from the regions. Added to this, his industry is still very fragmented, which means opportunities abound.
“We are fortunate that we have a good balance sheet,” he says. “We listed in October 2007, so we have still got cash to support acquisitions and can buy with part cash and part shares. There's no real debt in the company either.
“The industry is still a fragmented one. There was a period of consolidation about two years ago, but we are now looking at an environment where people are being more realistic about valuations, and are also keener to be a part of something bigger and to have some support around them. So this industry will carry on seeing a lot of consolidation.”
The difficulty for many buyers is that, at the moment, entrepreneurs are proving stubborn when it comes to valuations, refusing to accept that their business is worth far less than it was previously.
“If you look at AIM and the fall in prices, this is what should be happening in the private markets. But expectations haven't come down in line with this yet,” says Daisy Communication's Riley.
The valuation problem is compounded by the higher cost of debt for buyers. Jonathan Wright, chief executive of board-level recruitment company Hexagon Human Capital, says his acquisition strategy changed because of the crunch. However, when it comes to negotiating price, he recalls the wise words of a former mentor. “I used to work at Alexander Mann with James Caan, and he taught me one of the most important lessons about buying a company,” he recalls. “It was: decide what you are willing to pay for it, don't get emotional, and never pay any more.”
Like many entrepreneurs, Wright is now considering buying companies where the vendor has less say over the price. “Because of current low equity values, it is difficult to value businesses on an EBIT multiple,” he says. “However, I do see the potential to buy in situations where a company is in distress. Under these circumstances, the cash can be used as working capital and made to really work.”