Employee Equity can Improve the Chances of a Successful Restructuring

Businesses and the UK economy are under pressure from inflation thanks to increased taxes, such as VAT, and commodity prices and also pressure due to declining sales thanks to the reduction in consumer spending.

The current situation is as there has been a considerable amount of wage restraint in the marketplace with employees more concerned about keeping their job than earning more. This fear of job loss however does not apply to all staff, where retaining certain key employees is crucial as their loss would have an adverse impact on the business.

This is a common problem for restructuring advisers who need to solve it when dealing with companies in financial difficulties. When a business is in financial difficulty management often seeks to reduce staff costs such as by asking employees to take a pay cut in order to help the company survive and to keep their jobs.

Many attempts at restructuring insolvent companies fail due to flawed restructuring strategies and an inability to get the support of staff for a realistic solution. In the case of the Rover car company the opportunity was there to restructure the company using the £500 million dowry from BMW. But management failure and a lack of ownership of the problem by staff and their union representatives contributed to the company failing five years later when all employees lost their jobs.

Employees tend to be more concerned about the survival and future viability of their jobs than most other stakeholders. Banks and lenders tend only to be interested in the security of their outstanding loan, and shareholders often sell their shares or just ‘hang on and hope’ without further investment.

Involving employees in the development of a restructuring plan instead of imposing decisions on them can bring about solutions such as real cost savings and flexibility.

This notion of giving employees a greater say in their future exists in other countries, notably in Germany where employees’ representatives sit on the board of directors, and in the USA where unions like the Teamsters often hold shares in their member companies and are actively involved in strategic decision making.

The Deadline for Repaying Bank Bail-out Money Implies Continued Pressure on Business Lending

British banks have until 31 January 2012 to pay back the money made available to them by the Bank of England since April 2008 through its Special Liquidity Scheme, the support that was provided following the temporary public ownership of Northern Rock in the UK, the collapse of Lehman Brothers in the US and the onset of the global economic recession.

Where is this money is going to come from? The likely answer is from businesses and customers. While banks are likely to borrow some money via issuing corporate bonds in the marketplace it is unlikely there will be much inter-bank lending.

So it is reasonable to assume that banks will make up the difference by withdrawing money from the marketplace, that is from businesses and individuals from repayment of loans and overdrafts.  In addition to reducing existing loans, it will be difficult for banks to find new money for lending and businesses and other borrowers will find it harder to agree loans, and even if they are successful will find that repayment terms will be stricter and more costly.

The amounts involved are almost too big to imagine.  The amount due to be repaid is £185 billion which is similar to the combined value of the UK’s four leading banks (LloydsTSB, Barclays, HSBC and RBS).

At the same time the banks know they face tighter regulation on lending and capital reserves under new regulations, called Basel III, from the world’s banking regulator. Meeting these new requirements will require banks to raise substantial amounts of fresh capital placing further burden on the lending market.

At the same time the Government has now introduced a series of measures, including a rise in VAT, higher National Insurance Contributions and public sector cuts, aimed at reducing the country’s budget deficit.  The bulk of businesses on which the economy depends are small traders and entrepreneurs and if they are experiencing a combination of higher costs and tightly restricted lending they cannot plan for growth and increasing the profits they would need to be able to expand and in fact should be focusing on cash management and cash flow in order to survive.

It is difficult to see how a long gentle decline can be avoided in these circumstances, when the fact is that the banks must find the money for repayment somewhere. Double dip recession?

HM Revenue and Customs is Increasingly Rejecting CVA Proposals

It is not being much talked about in the marketplace but it is becoming increasingly common for HM Revenue and Customs (HMRC) to reject Company Voluntary Arrangements that would previously have been accepted.

In the past HMRC has appeared to be a great supporter of CVAs, but recently they have been rejecting a number of CVA proposals that they would have approved in the past.

While there are no published statistics on the numbers of liquidations resulting from failed CVAs, historically a large percentage have failed. Business rescue advisers and insolvency practitioners believe that the failure rate of CVAs post approval is somewhere between 60% and 70%.

HMRC website guidelines to case officers indicate that they should attempt to get arrears repaid within 12 months with longer periods being the exception. This may explain why HMRC is now rejecting more proposals.

A CVA can be used to improve cash flow quickly in order to keep trading while paying off its debts in a manageable way.  It is a legally binding agreement between an insolvent company and its creditors to repay some, or all, of its historic debts out of future profits, over a period of time.

For a business in difficulty a low level of contributions in the early period of a CVA allows it to get back on its feet in the short term while refocusing the business on survival and increasing profits, thus enabling it to pay higher contributions later in the CVA.  This increases the chances of the business being able to maintain its payments throughout the CVA period and reducing the risk of failure. High repayments required in the early stages will mean it cannot do this.

However, many CVAs are drafted by insolvency practitioners with a view to the proposal being approved, and as a result many of those being approved today are offering significant contributions to creditors, some exceeding 100p in the £.

While the greater contribution improves the chances of a CVA proposal being approved by creditors, the lack of realism about a company’s ability to achieve the commitments is the reason for such a high failure rate post approval.

Business Survival Depends on Stakeholder Co-operation and Collaboration

The support and co-operation of its stakeholders can be crucial to the success or failure of the efforts by a business in difficulty to restructure and survive.

Stakeholders are all those people who have an interest in the business and are likely to be affected by its activities and most crucially by its failure, and they include shareholders, investors, creditors, the bank, suppliers, landlords, employees (and their union representatives) and customers or clients.

Plainly, when a business is in difficulty and has called in a rescue adviser to review its activities, costs, business model and viability, any actions it may need to take as a result will be more likely to succeed if its stakeholders both understand the situation and support the proposed solutions.

While there is one key interest that all hold in common, which is that all have an interest in the business surviving if they want to continue to receive income from it, it is probable that the interests of some stakeholders will conflict with those of others.

Employees will be most concerned about keeping their jobs and their co-operation in any restructuring is likely to depend on whether they feel the management is considering their concerns as well as involving them in the changes that may need to be made.  If there are unions involved getting them on board can be the key to persuading employees to co-operate.

Creditors and investors, on the other hand, may just want to be paid what they are owed and whether they are prepared to forgo or renegotiate payments or finance in the short term will depend on how much confidence they have in its future. 

The bank’s primary concern is to ensure loans are secure, safe and will be paid and will want to be kept informed as well as being given evidence that the business has been properly looked at by a specialist adviser, shown to be viable and any proposals are realistic and have a good chance of achieving the desired results.

It is crucial that the rescue adviser is involved in the management of the stakeholders thus ensuring that their concerns are understood. This will go a long way to ensuring stakeholders’ co-operation.

How Many High Street Names Will Survive to the End of 2011?

Traditionally UK retailers expect sales in the fourth quarter of the year(Q4) to be significantly boosted by pre-Christmas shopping and by year end sales.

However, according to figures released on January 21 by the Office for National Statistics retail sales volumes dropped 0.8% in December compared with November. It was said to be the weakest annual performance for any December since records began in 1988.

Among those that have already reported sales drops are Clinton Cards, with sales down by 2.1% in the last five weeks of the year, and Mothercare posting a drop of 4%. HMV reported falls in December sales of 10% in the UK and 13.6% in Ireland and issued a profit warning.  Next said it had lost £22 million in Christmas sales.

Many blamed the three weeks of December snow that seized up the UK’s transport system and even online shopping options were no help because many distribution services were unable to guarantee pre-Christmas deliveries.

Sainsbury’s, however, reported sales up 10.1% for the four weeks to December 25, compared with the same period in 2009.

The Q4 figures and further retail results may show that there has been some late-December cheer as consumers rushed to beat the January 4 VAT increase, from 17.5% to 20%.

But it is looking as if the end of year boost the retail sector traditionally relies on may not have quite materialised for most and may have left them less well placed to face the difficult trading conditions expected in 2011.

The most difficult issue facing retailers will be maintaining their profit margins. Margins may have been propped up in December-January by the rush to beat the VAT increase, especially on the larger items but commodity prices on basics like cotton, wheat, rice, maize and sugar are expected to continue to rise thanks to global financial speculation.

Without a fundamental examination of the business, cost cutting (wages, premises,  equipment etc) may not be sufficient for survival in current conditions.

Perhaps a high street retail presence is no longer sustainable and more fundamental and innovative solutions, such as moving the emphasis to online selling, may be the only way some retailers can survive.

The Focus Must be on Cash Management When Times Are Tough

Profit and turnover are, of course, important measures of business performance but when times are as difficult as they are at the start of 2011 and many businesses are finding themselves in difficulties the main focus must shift to cash.

Cash flow is the most immediate indicator of the way a business is performing and can also provide a warning signal that action needs to be taken to prevent a slide into insolvency.

Close attention to cash flow should give a clearer picture of the immediate state of the business but while it may be possible to adjust to strengthen incomings against outgoings this is only going to be a holding operation.

The business must also look at its business plan and business model, preferably with the help of a turnaround adviser.  An objective outsider working as part of the business team to secure its medium and longer term future may identify fundamental weaknesses that undermine the ability to control cash flow.

The first step in managing cash is to construct a 13-week cash flow forecast to help identify risks and actions that can be taken to reduce them. It should include income from sales and other receipts and outgoings, both to ongoing obligations such as rent wages and finance and to creditors.

The business also needs to control cash on a daily basis, with payments made on a priority basis with purchases approved by an authorised person who is aware of their impact on cash flow. This will avoid the risk of returned cheques. It is also advisable to talk to the bank and keep it aware of what is being done to keep things under control.

Tight control of cash coupled with a thorough look at the business model and a realistic business plan will go a long way to help a business survive in difficult trading conditions.

Businesses Should Prepare Themselves for the High Level of Inflation

One of the greatest worries in the predicted difficult conditions of 2011 for both businesses and consumers is price inflation thanks in part to the increase in VAT from 17.5% to 20% from January 4 but also to the rise in commodity prices including basic foods and oil. 

Coupled with rising energy prices and public sector job cuts, this is expected to lead to a drop in consumer spending on non-essentials.

Businesses therefore need to protect themselves to ensure their survival and consider whether to concentrate on profits in the short term rather than longer term growth.

A high inflation rate makes it difficult for businesses to set prices. Normally when the inflation rate is climbing too quickly or remaining consistently high, interest rates will be increased in an attempt to bring it under control and eventually reduce it.

However, in an interconnected global economy, where most countries are subject to the same external pressures from such things as commodity price speculation on basic foods, speculation on futures in oil and minerals that are the raw materials used by manufacturers, it is being argued that this will not work now.

Financial engineering is being carried out well outside the influence of the government and beyond any attempts by the Bank of England to use interest rates to bring inflation down.  The question is whether in fact inflation is something to be worried about in current circumstances.

A UK business trading only in the UK will face a tougher time than a UK business focused on export, which can target the emerging BRICs with expanding middle classes that provide capacity for economic growth.

UK focused businesses in 2011 are therefore likely to be caught between a rock and a hard place and it may be that businesses should consider carrying out a thorough review to identify any cost savings they could make before the going gets any tougher.

The Questions HM Revenue and Customs Asks to Assess a request for Time to Pay Arrears

Recently uploaded guidelines for HM Revenue and Customs case officers dealing with requests from businesses in difficulty for time to pay arrears of VAT, PAYE or tax, reveal the detail of what questions will be asked before the request for a Time to Pay arrangement (TTP) can be considered.

Applicants must be able to show that they have tried to raise the money they owe by other means beforehand.  Individuals, which includes sole traders and the self employed, may be asked to show that they have approached their bank or asked friends or family for a loan or that they cannot pay the debt via a credit card.

However, the advice to case officers also states that for individuals “it is unacceptable for us to insist that a customer has made every effort to secure a loan before agreeing TTP” because it would contravene Office of Fair Trading Debt Collection Guidelines.

Both individuals and larger businesses may also be asked whether they have any assets that can be easily converted into cash or any savings that they could use to settle the debt, even if early withdrawal might incur a payment penalty. This also applies to endowment or life insurance policies, although the HMRC cannot insist that these are cashed to pay a debt.

The HMRC distinguishes between debts below £100,000 and debts above that amount and for larger businesses HMRC would want to see evidence, usually a letter from the bank, that the company has approached their bank and discussed borrowing facilities beforehand as well as exploring options for raising money from: shareholders, Directors, book debt factoring and invoice discounting, stock finance, sale and leaseback of assets or venture capital providers.

The case officer will also consider the applicant’s previous history of paying on time, whether they have had a previous TTP and previous difficulties will weigh heavily in the final decision and whether the business is viable.

It would make sense, therefore, to have a thorough business review and the support of a rescue adviser or insolvency practitioner to assess the business viability and explore all these options and to document them before approaching HMRC.

HMRC’s Assessment Criteria for a Time to Pay Arrangement for Revenue Arrears

As businesses face continued tough trading conditions in 2011 a new series of guidelines has appeared on the HM Customs and Revenue (HMRC) website on the arrangements for paying arrears of tax, VAT and PAYE, known as Time to Pay (TTP).

Although the guidelines are aimed at those working in the revenue they are equally useful for businesses in difficulties in outlining the questions and conditions businesses will need to be prepared for if they are in arrears with revenue payments and looking for a manageable way to spread the repayments.

Firstly, in all cases the repayment period to be set will be as short as possible and usually no more than a year unless there are “exceptional circumstances”. However long the arrangement, interest will be charged while the debt remains outstanding.

There is no entitlement for a business to be granted a TTP.  HMRC officers must consider the timescale being requested by the “customer”, their previous payment history and the amount outstanding. 

Businesses must meet two further conditions and they are that the applicant must have the means to make the agreed payments as well as the means to pay other tax liabilities that become due during the TTP period.

Finally, the guidelines make it clear that the preferred method of dealing with TTP requests is by telephone, because it allows for detailed questioning of the viability of the business, and as part of the assessment of whether the situation is a “can’t” or a “won’t” pay.

The amount of detailed information that will be requested from the applicant will vary according to the level of the debt, divided into three categories, for debts below £100,000, from £100,000 to £1 million and for more than £1 million.

Whatever the level of arrears, for a successful TTP to be achieved any business in difficulty is strongly advised to be honest with itself and its advisers about all its outstanding debts and liabilities if it is to be able to stick to any TTP arrangement.

It is crucial that before the telephone conversation the applicant has all the required information on income and expenditure prepared and ready so that they can remain calm throughout what can be a stressful situation.

Guide to Company Voluntary Arrangements (CVA) and When to Use Them

A Company Voluntary Arrangement (CVA) is a binding agreement between a company and those to whom it owes money (creditors).

It is based on a proposal that will include affordable, realistic and manageable repayment terms. It normally allows for repayment to be spread over a period of three to five years and can also be used to offer to repay less than the amount due if this is all the company can afford.

The proposal is sent to the Company’s Creditors along with an independent report on the proposal by an insolvency practitioner acting as Nominee.

Creditors are invited to respond to the CVA proposal by voting to either accept it, or reject it, or accept it subject to modifications that the Creditor proposes as a condition of their vote for acceptance. The votes are counted by value of claim where the requisite majority for approval is 75% of the votes cast. This is subject to a second vote to check that 50% of the non-connected creditors approve the proposals.

A CVA can only be used when a company is insolvent but it can be used to save a company rather than close it when creditors are pressing including when a debt related judgement can’t be satisfied or a creditor has filed a Winding Up Petition (WUP).

In addition to proposing terms for repaying debt, it helps to include details of any restructuring and reorganisation along with a business plan so that creditors can assess the viability of the surviving business. The proposals must be fair and not prejudice any individual or class of creditor including those with specific rights such as personal guarantees. These include trade suppliers, credit insurers, finance providers, employees, landlords and HM Revenue and Customs, the latter often being key in view of the arrears of VAT and PAYE that many companies have built up.

A CVA should only be used when the company’s directors are willing to be honest with themselves and face up to the position the company is in, preferably with the advice and guidance of an insolvency practitioner or experienced business rescue advisor but used properly it can improve a company’s cash flow very quickly by removing onerous financial obligations and easing the pressure from creditors.