Survival sometimes needs Fundamental Change

Any successful business would be expected to be constantly monitoring its activities and modifying them where necessary to improve the efficiency and its various offers.

Continuous business improvement does two things: it optimises existing processes and keeps them optimal by continually updating them. 

But on its own, especially when there are significant challenges in the wider economy, such as the current global economic downturn, continuous improvement may not be enough.

Such unexpected challenges can plunge a business into difficulties where its survival may be at stake and this may mean looking at a fundamental change to the way it operates.

Too often businesses struggling to survive, are characterised by hard work and trying to improve the existing business model before they fail.  Business improvement is all about laying foundations, tweaking the system and improving. 

In my view fundamental change is a more radical look at the whole operation but it also needs care to avoid throwing the baby out with the bathwater by looking hard at the business and what needs to be preserved in order to survive and grow in the future. However, if a business tries to grow before bedding in new foundations following fundamental change it will reinforce problems that had not been sorted out.

For example in a downturn it is an understandable reaction for a business to trim its costs when it may be better to have an in-depth look at its business model and be open to more radical changes.

This can all seem too much when a company’s directors are struggling to keep a business afloat at a difficult time.  It is possible to be too close to the problem, however, and a combination of worry and a sense of urgency is not ideal for taking an objective look at the whole business model.

This is where calling on a business turnaround adviser could make all the difference between success and failure.  The adviser is motivated to help a business succeed and will expect to work with committed managers and staff, but they are not so immersed in the day to day minutiae of the operation and can therefore look at all aspects of the business, identify what is viable, what processes are draining the company and what actions can be taken.

Working With Trades Unions to Promote Consensual Turnarounds

I have approached a number of UK trades unions with a view to forging a collaborative approach to dealing with companies in financial difficulties. 

In my view, currently, employees are rarely involved in the decision-making when a company’s survival is threatened, but a successful business turnaround relies very much on the support of its employees.

Unlike formal insolvency procedures, turnarounds are consensual. Leadership, teamwork and communication are key to implementing change. Engaging with staff and involving them in the business introduces accountability and responsibility to a business and is crucial to its success. This is even more so with a turnaround where change is necessary.

Historically turnarounds have been co-ordinated by banks as secured creditors, or by new investors who drive change from a purely financial perspective, oriented towards achieving single stakeholder objectives.  What gets measured, gets managed. 

Many stakeholders have compromised their credibility with employees by this pursuit of short-term objectives of repayment of their investments with little interest in a company’s survival.  

So who is really interested in the employees let alone securing their employment for the future?

The trades unions are still believed to be the true representatives of employees’ interests and while the relationship between management and union representatives has in some instances become polarised this is not helpful when trying to save a fragile business. It is rather like the surgeon fighting with his medical team when a patient’s life hangs in the balance on the operating table.

This new initiative to collaborate with trades unions is based on developing a mutual respect and understanding of each other’s objectives outside the constraints of a turnaround situation.

Union input can be valuable when considering the thorny problem of how to reduce staff costs, where hard choices might have to be made between cutting numbers, wages, hours, or benefits. Their involvement helps remove fear among staff by reassuring them that their interests have been taken into account when developing the turnaround plan.

A Business in Difficulty Can Terminate its Property Leases and be Fair to Landlords

In April 2009 the retailer JJB successfully proposed a CVA designed to save 250 stores and 12,000 jobs. It has become the model for subsequent CVAs in the retail sector.

The proposal included closing 140 unprofitable stores but made available a fund of £10m for the landlord creditors of these premises, equating to a payment of approximately six months rent and JJB also made a significant compromise in bearing the substantial costs of the business rates of the unprofitable stores.

No leases were ‘torn up’ by the CVA and it was left to individual landlords to decide whether they wished to accept a surrender, consent to an assignment or forfeit the lease. The landlords as a group recognised that there was a substantial risk that JJB would go into administration, with a loss of their payments of rent or business rates for the closed stores and appreciated being consulted in a transparent process and being offered a genuine compromise.

It often happens that the core of a struggling business is viable and it need not go into administration if it can be restructured to focus on the parts that are profitable.

That can be beneficial to the creditors too, because they will then see some return on what they are owed, as the above example illustrates. In many cases the creditors will include landlords who own the property or properties from which the business is trading.

The forced termination of a lease can only be done by a liquidator following a company’s liquidation. If a company goes into administration and is sold the Administrator can also force termination of those leases no longer required.

However, in the JJB illustration negotiation with the landlords to terminate some leases was made possible by proving to them how much they would receive in the event of a liquidation and showing that the alternative offer set up using a Company Voluntary Arrangement (CVA) was better than liquidation.

Forcing a change in the terms of a lease is extremely difficult and the courts will want to test whether or not a landlord has been treated fairly as a creditor in a CVA, regarded as vertical and horizontal tests.

Cash is King When a Business is Facing Financial Pressure

A company can be said to be insolvent on any one of four tests: the cash flow test, balance sheet test (negative asset value), an unsatisfied judgement (usually a county court judgement) or an outstanding statutory demand.

Of these four, the most crucial is the cash flow test which looks at whether a company can pay its liabilities as and when they fall due where late payment of creditors indicates that a company is suffering cash flow problems.

Running out of cash is the cause of most business failures and it happens chiefly  for three reasons: the bank freezing the company account, a restriction in the company’s ability to draw down funds possibly due to the lack of available credit and thirdly, a sales ledger issue where the company can’t draw down funds from factoring either because invoices have not been logged, or because of declining sales, or overdue or disputed invoices.

If the company’s relationship with its bank is under pressure then the causes and effects must be examined. Banks generally would prefer not to close down businesses and only usually start to get tough if  a business consistently tests its overdraft limit, company cheques cannot be honoured and the business does not communicate or  provide sensible financial information if asked for.

It may be that the company is forced into an onerous factoring arrangement that will benefit the bank but can reduce funds available putting further pressure on cash flow.

If the sales ledger system is not being kept up to date accurately or there are issues with suppliers over invoices then the system needs to be looked at thoroughly and a more robust set-up may need to be put in place.

In terms of cash outflow, there are two main tensions that can result and they are the inability to pay outstanding bills and the inability to pay future bills. In this situation prioritising payments becomes essential.  This is critical if a company has decided it is insolvent because it must act in the best interests of its creditors and needs clear principles for making payments to avoid personal liability.

In these circumstances unless a company is familiar with this sort of situation it would be advisable to take advice from a specialist restructuring adviser, who will have a number of strategies available to help and it may be that at its core there is a viable business waiting to be unlocked.

A cash flow crisis is an alarm bell sounding that should indicate that the business needs to be properly assessed with experienced outside help.

Employing Restructuring Advisers to Help Save Your Company

There are a number of options for companies who find themselves in financial difficulties, but a real challenge is finding someone to help.

It’s made more difficult if the directors/owners take the view that they know their business better than anyone else and infer from this that if they don’t know the solution, then no one else will.

A second issue is trying to solve the situation alone, via a self-help route.  It may be that research has revealed a number of options and in a situation of financial difficulty there is a temptation to latch onto the cheapest or first solution. Indeed, you are likely to think you can’t afford help and as a result persuade yourself that the cheap solution is the right one. It is no surprise that a lot of companies fail having not sought any advice.

In either situation eventually a squeeze on cash flow or pressure from creditors tends to be the catalyst that galvanises action and you are likely to start looking for a solution.

Who do you turn to for help when feeling as boxed in as this?  What’s needed is a business rescue adviser, but how do you go about the process of finding one from among the insolvency, turnaround, accounting and consultancy advisers?  

Carry out a thorough vetting process to confirm they have suitable experience and offer a rescue process rather than selling only one rescue solution. The rescue process should involve a thorough business review to identify a viable business that can emerge from the process, then developing and implementing an operational reorganisation and financial restructuring plan. One aspect of the financial restructuring plan will be how to deal with all the company’s liabilities.

In addition to bank and trade creditors a key creditor is likely to be the HMRC (Her Majesty’s Customs and Excise). Too often companies are advised to enter a Time to Pay arrangement with the HMRC to deal with tax, VAT or PAYE arrears or to enter a Company Voluntary Agreement (CVA) to deal with debts without a realistic assessment of the other demands on the company’s cash.

The first thing to find out, therefore, is whether the adviser is selling something or has a vested interest in the company pursuing a particular solution. Having established they are truly independent, the adviser will conduct a review to establish the core issues.

Support from business rescue advisers with broad commercial experience, not just insolvency, will help manage the process while at the same time helping find a realistic solution.

Redundancy Costs Due to Staff Reduction Can Leave a Company Insolvent

Companies struggling to survive a severe economic downturn like the current one often consider ways to reduce their overheads.

Generally one of the biggest costs on a business is the payroll and looking to redundancies as a way to reduce them is a common response to a recession.

The reasons used for making employees redundant are generally economic, technical or organisational. This can be that new technology or a new system has made a job unnecessary, the company needs to cut costs or that the business is closing down or moving.

However, making staff redundant is closely regulated and there are rules for the steps that a business must follow if it chooses to go down this route. These can be extremely expensive and if not managed properly could actually leave the company insolvent rather than achieving the desired objective.

Firstly, many companies consult employment specialists to ensure that it complies with the rules and carries out the process correctly and this in itself can involve paying substantial fees.

If an employer is making fewer than 20 employees redundant in one establishment it must consult individually. 

For more than 20 employees being made redundant within a 90-day period it becomes a collective redundancy and the employer has a duty to consult with representatives of the potentially affected employees. If the employer does not consult then the employees can apply to an Employment Tribunal claim for a protective award. This is an award of up to 90 days’ pay.

Rules about employees’ redundancy entitlements are laid down by the Government. The calculation is based on how long the employee has been continuously employed, their age and their weeks of entitlement up to a certain limit (£380 per week current allowance).

Failure to carry out a redundancy operation can also result in employees taking the employer to a Tribunal with a claim of unfair dismissal. In certain circumstances this can also add to the employer’s costs, not only if the Tribunal rules in favour of the employee but also, in some specific circumstances Tribunals now have the power to award costs of up to £10,000. 

A better option for cost reduction before going down the redundancy route could be to call in a business rescue adviser to carry out a thorough review of the business to assess the business viability, look at its accounts and business model, identify any underlying weaknesses and suggest a restructuring plan.

Are Government Insolvency Statistics Concealing the Number of Insolvent Companies?

As a consequence of the global financial crisis it is reasonable to assume that the numbers of companies in financial difficulties serious enough to precipitate insolvency would be increasing.

However, figures for the second quarter of this year released by the UK Insolvency Service in August show that there were 2,080 companies in England and Wales that were placed into liquidation.

These are made up of compulsory liquidations and creditors voluntary liquidations and showed a 0.5% increase on the previous quarter but a decrease of 19.1% on the same quarter in 2009.

Compulsory liquidations were down 9.9% on the previous quarter and 21.0% on the corresponding quarter in 2009, while creditor voluntary liquidations were up 5.4% compared with the previous quarter but down 18.3% compared to the same quarter in 2009.

It would be tempting to infer from these figures that the economy is beginning to recover and the pressure on companies is easing.

It is possible, however, that the decline in liquidations is concealing the number of companies in financial difficulties because of a lack of pressure from creditors other than the HMRC (Her Majesty’s Revenue & Customs ), the only active creditor currently seeking winding up orders in the courts.

The Government’s Comprehensive Spending Review in October may reveal the full impact on UK insolvencies.

Even if the UK avoids a double dip recession, there is a risk that the UK economy could develop a twin track economy, with public-sector-dependent industries facing higher levels of financial distress than sectors which are less directly linked to government spending cuts.

Some commentators argue that while Corporate insolvencies are still well below the numbers that would normally be expected at this point in the cycle the slight quarterly rise in the number of liquidations may signal that conditions are starting to turn against UK companies once again.

The lower than expected number of insolvencies is ascribed to a variety of proactive measures, HMRC Time to Pay arrangements and bank forbearance, together buying time for companies to deal with their financial situation. However, this may perhaps have only delayed the inevitable for others that are less robust or those that fail to use the time by taking remedial action to reduce costs or implement other steps that ensures survival.

Managing Tax Payments with Time To Pay Arrangements

There are hundreds of thousands of businesses struggling to meet their financial obligations to the Exchequer.

Businesses, especially smaller enterprises, have been reporting that in the current difficult economic climate they are struggling with cash flow issues as customers and suppliers try to stretch out the time they take to pay invoices. That means they may not have enough liquidity to pay the tax they owe.

While the majority of these tax monies are repaid, the HMRC (Her Majesty’s Revenue & Customs) has reported that 10% of expected revenues are outstanding.

The UK’s Time to Pay (TTP) scheme was introduced in 2008 and allows businesses to pay overdue tax bills over a certain period of time. The scheme is administered by the Businesses Payment Support Service.

According to the HMRC website, arrangements are tailored to the ability of the customer to pay and are typically for a few months although they can be longer.

TTPs lasting longer than a year are only agreed in exceptional cases. Most arrangements involve regular monthly payments being made but in exceptional cases may involve a short period of deferral.

All businesses seeking a TTP of £1m or more need to pay for an Independent Business Review (IBR) to be carried out by an approved firm, normally an insolvency practitioner, and a total of 13 firms have been approved by HMRC to carry out IBRs to establish whether the business can pay back their deferred tax bill.

When the restructuring plans are ready, a business rescue adviser would normally expect to bring in an HMRC approved firm that they already know. The IBR would assess the company’s ability to eventually pay back any tax deferred by HMRC based on a review the proposals prepared by the adviser. These would be prepared with view to demonstrating a viable business.

The most recent statistics issued by HMRC are from March 2010 when it was revealed that 300,000 businesses have entered TTP arrangements since the end of 2008, deferring at least £5.2bn in business taxes. That equates to an average of 4,500 a week.

Concerns have been raised that it is getting tougher to join the scheme, and there have been some predictions that it would eventually have to close. However HMRC has insisted the TTP is still available and the eligibility criteria have not changed. The UK Coalition Government’s Business Secretary Vince Cable, speaking at a recent Institute of Directors event, reinforced this by saying that his department’s instructions to HMRC was to still make it “easy” for applicants to agree TTP arrangements.

Dealing with VAT Arrears and PAYE Arrears

Owing HMRC (Her Majesty’s Revenue & Customs) more than £150,000 for overdue VAT and PAYE when your turnover is less than £3 million is not uncommon in 2010.  

The leniency of HMRC, whose light touch approach to collecting Revenue arrears since the recession began has helped the cash flow of many companies, has also made it easier for them to accrue both VAT and PAYE arrears. But the lack of a recovery has left companies in arrears burdened with debt they can’t easily repay.

Companies in this position have a number of options, but a real challenge is when to do something about it. If ignored, the liability can build up and the underlying business problems can escalate to a point where the company can find it more difficult to recover.

While directors are normally aware of the problems, and in particular of the liability in respect of Revenue arrears, they may not be aware of their options, assuming: “I know my business better than anyone else and if I don’t know the solution, then no one else will.”

Consider three financial solutions when dealing with HMRC arrears. They are immediate payment, a Time to Pay (TTP) arrangement or a Company Voluntary Arrangement (CVA). However, all too often one of these is implemented without considering other issues that perhaps need to be addressed at the same time.

The build up of PAYE arrears and VAT arrears is an indicator that the business is no longer profitable or that it doesn’t have sufficient working capital. The underlying issues can be identified by a business review and preparation of forecasts. It is obvious that an unprofitable company cannot achieve a payment plan while also covering ongoing payments. Less obvious is the restructuring and reorganisation that may be needed to achieve a viable business, one that is profitable with adequate working capital and positive cash flow.

Surviving the pressure of PAYE and VAT arrears generally involves more than just fixing the financial problem.  the underlying issues need to be identified and workable solutions put in place.

A Winding Up Petition Due to HMRC Arrears Need Not be the End

In early 2010 HMRC (Her Majesty’s Revenue & Customs) served notice for a Winding up Petition against a small trading company. The company had ignored HMRC for three years and had not submitted accounts for three years, not since 2007.  A director attended the winding up hearing in court unrepresented.  He said he was trying to reach agreement with the Revenue and was granted 3 weeks stay of execution.

During the three weeks the company sought our help and experience of turnaround and insolvency, to advise on restructuring options, help develop and implement a rescue plan and also help manage the court process.

After a business review, we concluded that it was possible to buy some time to allow the company to be restructured. We first recommended that a barrister should represent the company at the adjourned hearing.  The barrister successfully sought a six-week adjournment to give time for a rescue plan to be put in place, including proposing a Company Voluntary Arrangement (CVA) for approval at a meeting with creditors. This strategy was achieved and at the third hearing the petition was dismissed.

Winding-up petitions are generally used for two purposes:

They may be used as a final attempt by a legitimate creditor to force the debtor company to respond following previous failed attempts to contact them to try to agree payment terms for the outstanding liability.

They are also used to bully a debtor company into settling an outstanding liability, whether disputed or just to get paid before other creditors.

This second reason is often an abuse of process, where the courts are easily deceived. Procedure in court is often key, especially when experienced creditors who know how to play the court ‘game’ use barristers to deal with innocent directors doing their best to represent the company without expert advice.

Winding up petitions in themselves don’t mean that a company is insolvent but they do indicate underlying issues that have not been addressed. The issues can include a lack of cash to pay bills on time, being unaware of legal process, or a dispute that has been ignored or spilled over into frustration.

The courts are aware of this and tend to be lenient towards directors who ask for time to resolve the petition by granting an adjournment. However, their attitude hardens if, at the adjourned hearing, it is shown that the director has failed to fulfil the undertaking given at the earlier hearing.