Company turnaround acquisitions
Matt Thomas reveals how to make sure what seems a small gamble doesn’t end up costing your business a fortune
Everyone loves a bargain, especially entrepreneurs.
The entrepreneurial DNA demands that at least once in your career you’ll be tempted by the prospect of buying a business down on its luck, giving it the kiss of life and taking the plaudits and profi ts when it returns to good health. More frequently and less egotistically, you’ll see a business struggling that you think needn’t be, and view it as an acquisition opportunity. But while it’s perfectly possible to benefi t from someone else’s misfortune, the harsh reality is that it’s rarely as straightforward as it looks. There’s no escaping that while the price tag might be small and the potential return great, you’re actually making an extremely high-risk investment – so how do you decide if a failed business is worth a punt?
It never costs a pound
It’s fairly obvious the reason entrepreneurs buy failed businesses is they’re usually going cheap. The press loves reporting the token sum a business exchanges hands for and entrepreneurs yearn to boast, ‘I only paid a pound for it’. But let’s get one thing absolutely clear, buying a failed business and making it work, will not, under any circumstances, cost you as little as a pound. You’ll either be buying a business on the verge of collapse with so many debts it has very little actual value to the seller, or you’ll be buying out of administration where you are picking up the assets, although without the liabilities, once it’s all gone publicly wrong. Either way, you’re buying damaged goods. The cost to put right that damage is where most turnarounds fall down – and where people seeking a quick-return end up losing a lot of money. George Moore, an expert in turnaround acquisitions, says: “It’s mostly fools’ gold – business recovery is very hard and you almost always have to be prepared to put a lot of capital in to make it work.”
Recognising turnaround potential
Even in the hands of the most capable turnaround expert, some businesses will be beyond saving. Recognising a business has no turnaround potential is just as important as identifying one with it – and in the long-run will probably make you more money. Rob Donaldson, a partner at Baker Tilly, says: “If the fundamentals are poor you can’t do it. If it’s manufacturing and it can be done cheaper in China then you won’t be able to do a lot with it. However, if it’s just been poorly managed, then that’s a green light to look further.” “It’s all about risk versus reward,” says Nick Hood partner at Begbies Traynor. “Your first question needs to be ‘how bad is it?’ then it should be ‘what is the cash requirement?’ – and I’ve never seen a failing business that doesn’t have one.” You must price everything from the worst possible scenario, advises Hood. “Plan for sales falling, new equipment, expensive sales people, marketing costs and then work out how long it’ll be before it’ll be profi table. If you’ve got to increase turnover by 50% then you have to consider if that’s an impossibility.” If the business has a strong product and willing consumer it must be failing elsewhere. Perhaps it’s been managed poorly, needs investment in technology to make it more effi cient, has marketed itself expensively or perhaps it’s struggled to cope with debt. If it’s one of these, it may be turnaround-able. Consider if you could improve effi ciency or increase yield through: ? economies of scale; ? access to wider distribution; ? reducing overheads through synergy; ? overseas labour or production markets; ? applying your superior brand Restaurant chain Loch Fyne decided in 2003 it wanted to take on another brand and identifi ed Le Petit Blanc as a potential acquisition. It had fallen into administration despite enjoying high visitor levels. It was this that convinced Loch Fyne co-founder and MD Mark Derry that it could be turned around. “It had a proven formula and customer acceptance with excellent sales, yet the business was failing,” says Derry. “It was taking a lot of money but spending a lot too so it was clear the problem was in the administration and we thought we could change that.” For Hood, the high profile acquisition from administration of Red Letter Days by Theo Paphitis and Peter Jones, is another example of “a classic good idea, run badly, being bought for turnaround potential”. However, Hood insists the partnership still faces a signifi cant challenge. “They’ve bought a brand and not much else. It appears a very reasonable punt – but it’s still a risk.” Risk is the element you should be looking to reduce throughout the whole process. At every stage, it’s essential to think, ‘is this still a good idea?’. If it’s not, move on. If it is, continue digging.
In a fi nance deal, as anyone who has raised VC funds will vouch, no stone goes unturned during due diligence. When you’re buying a business, particularly one that’s in a mess, it’s a case of snatching glances under as many stones as you can. You’ll never get the full picture, but every snippet of information you uncover will reduce that risk factor. “You’ll be under intense time pressure,” warns Donaldson. Tony Edwards, a partner in corporate fi nance for law firm Stephenson Harwood, says: “There will be all sorts of problems you’ll need to get to the bottom of. You want to know if supplier contracts have clauses that can be triggered and if you can renegotiate them. You need to know if there are any outstanding claims, disputes or issues with real estate or environmental issues. You need to know what is going on with pensions; if there is a scheme with defi ned benefi ts and if it’s under-funded.” For Derry it was a case of finding out where and why money was flying out of the business. “We got to see the sales books and profi t and loss account, which showed the labour costs were far too high. They had marketing managers for each of their four sites, there were too many chefs and the food was costing a lot to produce.” In Derry’s experience, the management were very open to the assets being explored. However, Hood’s cynicism that generally you should take the vendor’s word on the true state of assets “with several pinches of salt” is shared by most. The overriding advice is to dig as deep as you can and talk to as many people – staff, suppliers, creditors, debtors, landlords – as possible, whether or not you’re given permission. “Quite simply you need to ensure the assets you’re paying for exist,” says Moore. “But you need more than that. Talk to creditors and see what their attitude is. If there’s a debtors book fi nd out how much is likely to come back.” In addition to an experienced accountant and lawyer, it could be wise to use the services of an independent assessor or insolvency practitioner. “They will look at the situation without emotion,” says Hood, “and ask all the ‘yes, but what ifs’ and ‘I don’t believe thats’ in the right place.” Sometimes, however, the information won’t be accessible. This should set off warning bells. James Grenfell, a corporate fi nancier partner for corporate recovery experts Kroll, says: “If you can’t access the right people then you quite simply can’t do a deal. You should expect to walk away from one in 10 deals.”
Warranties and administration
If you’re buying a business or assets out of administration, you are free from any liabilities. That’s not to say you won’t discover any black holes or complications so due diligence is just as important. However, you won’t receive any warranties either. If you’re buying before administration you take on the company’s liabilities and so can negotiate warranties – however it’s a grey area. Donaldson says: “Try and get warranties but you’ve got to ask what the value of them is if the business is struggling – will there be anything to claim against?” Hood adds: “In a perfect world you’d want to say ‘I’ll buy this for a pittance and bring it back if it isn’t quite what I was told it was’, but it never works like that.” Edwards agrees and points out that “warranty claims are pretty rare” and not always benefi cial, particularly if a company subsequently goes bust, leaving you no means of recourse. “I would never buy other than through administration,” says Moore. “You can’t bottom up, the minute you take over worms will crawl out the woodwork everywhere. If they start making statutory demands and you haven’t got the cash to pay them you’re stuffed. You’re crazy to take on liabilities.” Probably due to the circumstances in which they enter businesses, administrators are often viewed negatively. However, it’s their job to fi nd the bits worth buying – the process that enables you to cherry-pick assets you’ve identifi ed as recoverable. It’s still a risk, though. “You have to make a judgement call,” says Grenfell, “and the best way is to talk to people.” Joanne Wright of Kroll’s corporate recovery department insists it’s becoming easier to do this. “We’ll block timewasters on a fi shing trip but not serious buyers. And if the administrator has done a good job at the front end then it’s usually a lot easier.” Again, it’s advisable to take both legal and practitioner advice although Grenfell highlights that once the due diligence is in place, the risk assessment decisions are down to your judgement.
It’s sometimes possible to agree with the sellers of a struggling business to place it into administration for the purpose of taking it on without liabilities. The term ‘pre-pack’ is used for this and it often results in a quick deal. Administrators can be cagey about pre-packs though as they’re under legal obligation to get maximum value for the creditors. Wright says: “It can leave a bad taste behind if it appears a quick and dirty deal where you just tell everyone after it’s done. It’s critical the business still goes for the best possible price, but works if the business has already been well-marketed for buyers.”
How you make it work
Of course, buying a business is only half of it – the real challenge is making it work. Even if you’ve identifi ed how you can improve a business you need to consider how it’ll work in practice – it certainly won’t happen on its own. “I’ve seen many good companies dragged down by a bad acquisition,” warns Hood. Most acquisitions are, quite sensibly, in the same sector and are seen as a growth strategy or ‘bolt-on’ to the existing business. In this case, it’s common for the buyer to look to integrate departments and make synergy savings in HR, sales, marketing and accounts. However, it’s rarely straightforward and disposing of excess staff, inappropriately or not, can be high risk. Failed businesses always need special attention initially so it’ll have different needs to your core company. This needs to be well managed – can you afford to lose your accountant for six months? The considerations need to go into your ‘worst case scenarios business plan’ from day one. For Derry, he decided to integrate everything but the actual Le Petit Blanc restaurants into Loch Fyne. “You have to fully integrate otherwise the costs are too high and you can’t keep an eye on problems. We don’t like surprises and get sales reports sent to our mobiles at 9am every morning. You need an open book to manage cashfl ow.” Le Petit Blanc is now into profit and has bolstered the group’s overall turnover to £30m. However, integration wasn’t without problems. Derry took a ‘softly softly’ approach to changes but then found staff were reluctant to switch to the Loch Fyne way. Consequently the process took two years instead of the planned 12 months. “We didn’t go charging in and perhaps with hindsight we should have made changes a few months earlier,” he admits. “However, it’s very hard for staff who have worked through an administration.” Donaldson agrees and says taking your time and applying a degree of sensitivity has its rewards. “You don’t want to throw the baby out with the bath water,” he says. “Find out who the real drivers are and do your best to keep them. Remember staff will be demoralised and the best will find jobs the quickest.” Donaldson also warns that you can’t expect businesses to seamlessly fall together. “It won’t happen in auto pilot and it doesn’t always make sense. Sometimes you can do more damage by throwing departments together and it makes more sense to look where you can cross-sell instead of trying to make cross-savings.”
Of course, you might not be buying a business as a ‘bolt-on’ and asset stripping, regardless of its negative image, is a valid way to make a profi t while saving elements of a business. You might also decide you don’t want some assets you’ve inherited. In this case, it makes perfect sense to move it on. However, if thinking of buying just to asset strip be totally aware of time pressures involved and consider whether the profi t is worth it with no long-term gains.
Taking a punt
By now, you should be thinking that there are plenty of reasons not to buy a failed business – and there are. However, that doesn’t mean it can’t be done. Hood concludes: “If you know what you’re buying and plan it well, it’s possible to get a very good business very cheaply.” Case study: Buying intellectual property as an asset Company: Silver Cross Owner: Alan Halsall Yorkshire-based Silver Cross had been manufacturing prams since 1877. However, it?s traditional elaborately-framed products fell out of fashion in the 1990s, as brands such as Mammas & Papas took control of the market, and it fell into receivership with heavy debts in 2002. Alan Halsall, a toy entrepreneur whose company had leased the Silver Chair for its miniature doll products, believed the business was beyond saviour but liked the brand and bought the company’s intellectual property. ?I contacted the administrator and made a bid for the IP and did a deal within two weeks. It was very easy because I knew exactly what I wanted. At the time people saw it as a tired old brand but I thought that was nonsense as the heritage angle gives warmth and a personal touch people like, especially when it comes to babies. “We were buying all our other products out of China and could see there was so much coming out of there but to make money you had to fi nd a differentiator and I knew ours would be the Silver Cross brand.” Halsall appointed Silver Cross’ old chief executive, flew him to China and employed a team of designers, sales and marketing staff to launch crossproducts made in the Far East bearing the Silver Cross brand. To ensure the brand keeps its heritage as well as competes in the modern design market, Halsall also produces a limited edition of the traditional product range from Yorkshire. Through celebrity endorsement from the likes of Angelina Jolie, Madonna, Rod Stewart and Britney Spears, Halsall has re-established Silver Cross as a leading brand and is now distributing to the world market, selling to Japan, Australia and the US. Halsall plans to license into other countries and plans to introduce spin-offs to make Silver Cross the world?s leading nursery brand.
10 THINGS YOU NEED TO FIND OUT
Equipment / technology: Find out if it’s actually there, how old it is, if it?s working and if it does the job.
Creditors: Who is owed what? What is their attitude? Are you sure more won?t come creeping out of the woodwork?
Debtors: How much is likely to come back in?
Suppliers: Speak to them and gauge their attitude. They?ll inevitably be owed money and won?t be happy. Will they be willing to work with you?
Contracts: Get as many as possible. Contact partners and try and get agreements in writing.
Records: Find out what state they?re in or even if they exist.
Stock: Check if it?s sellable. Assume the worst.
Property: Have lease payments been kept up to date? If not, can the landlord seize assets? Can you secure an ?assignment of the lease? and if you can will the landlord respond by putting the rent up?
Staff: Be honest where you can be but tread carefully. Know your TUPE obligations. Identify key staff and speak to them.
Disputes: Any previous, current or future disputes relating to activity before you took charge will be your responsibility. Find out everything you can.