Franchising Can Be Great if You do the Research and Check the Small Print

Many people dream of owning their own business and in the current economic climate are finding themselves pitched into starting up perhaps before they are quite ready.

A franchise often comes with an established brand, support in training, promotional materials and advice so it is tempting to see buying into a franchise as a safer option than going into business completely independently. 

But sinking savings or redundancy payments into any kind of business is a risk and a franchise is no different.

The big danger in taking on a franchise is getting a false sense of security that someone else is responsible for your business. They aren’t and a business plan is as important for a franchisee as for an independent trader.

Also, while the franchise provides support, it may also impose limits on independent action in order to protect its brand and reputation. The most successful franchises have tested their business model and methods and incorporated these into the package. It can happen that a franchise has failed because the franchisee has failed to follow the advice.

In a recent case of a franchise business in difficulty one of the biggest issues was that the franchisor declined to take any legal steps to protect its intellectual property or its franchisees’ rights.  

The franchise model offered complete geographical coverage and each local franchise unit’s success depended on the whole network‘s efficiency, but there was nothing to stop people who had gained privileged knowledge within the franchise from setting up in competition.

It is essential when setting up any business to scrutinise any legalities required, take advice and to negotiate. Until comfortable with the terms do not buy into a franchise.

Essentially, yes, a franchise can be a very good business opportunity but it does not eliminate much of the risk inherent in setting up a business and needs the same preparation work as for any business start-up.

Do Small Businesses Understand Working Capital and Liquidity?

When borrowing against current assets, such as the sales ledger using factoring or invoice discounting or against fixed assets like plant and machinery or property, there seems to be a widespread misunderstanding among businesses about business funding and, in particular, working capital.

While credit is the most common form of finance there are many other sources of finance and ways to generate cash or other liquid assets that provide working capital. Understanding these is fundamental to ensure a company is not left short of cash.

Businesses in different situations require finance tailored to their specific needs. Too often the wrong funding model results in businesses becoming insolvent, facing failure or some degree of painful restructuring. In spite of this, borrowing against the book debts unlike funding a property purchase is a form of working capital.

Tony Groom, of K2 Business Rescue, explains: “Most growing companies need additional working capital to fund growth since they need to fund the work before being paid. For a stable business where sales are not growing, current assets ought to be the same as current liabilities, often achieved by giving and taking similar credit terms. When sales are in decline, the need for working capital should be reducing with the company accruing surplus cash.”

Restructuring a business offers the opportunity of changing its operating and financial models to achieve a funding structure appropriate to supporting the strategy, whether growth, stability or decline. Dealing with liabilities, by refinancing over a longer period, converting debt to equity or writing them off via a Company Voluntary Arrangement (CVA), can significantly improve liquidity and hence working capital.

While factoring or invoice discounting, like credit, are brilliant for funding growth, businesses should be wary of building up liabilities to suppliers if they have already pledged their sales ledger leaving them with no current assets to pay creditors.

A Significant Increase in Winding Up Petitions

The last couple of months have seen a significant increase in the numbers of Winding Up Petitions (WUPs) being filed in the High Court.

K2 Business Rescue has been monitoring the number of petitions and notes that since April 2011 they have significantly increased.

Weekly averages of 100 WUPs were filed during February and March and have increased to 150 per week in April and May. This compares to a weekly average of 92 during the last quarter of 2010

Many companies in difficulty have been hanging on by their fingernails while hoping their sales will pick up.

While the picture and possible explanations are unlikely to be clear until the quarterly insolvency statistics are released, the increase in the number of petitions is likely to have been influenced by the enduring lack of cash with businesses trying to collect in their overdue debts.

A WUP is normally only filed after efforts to collect payment have been exhausted or more often ignored where the petition is a last resort, the result of frustration. This is certainly the case with HMRC who file most of the petitions.

In view of the rising numbers of compulsory WUPs it is possible that they may overtake the previously historically higher numbers of voluntary liquidations as creditors run out of patience.

Saving the High Street

Retail pain continues with the news that Mothercare is to close a third of its 373 UK stores.

JJB Sports has just announced losses 0f £181.4 million for the year to 30 January 2011, three times the previous year’s loss of £68.6 million and plan to close 89 of their 247 stores over the next two years.

And HMV has just had to sell Waterstone’s for £53 million to pay down some of its £170 million of debt. In addition, they also propose to close 40 stores.

Oddbin’s too, has gone like most other wine retail chains, following its failed attempt to agree a restructuring plan with creditors, which was rejected by HMRC.

Plainly there is a major earthquake taking place on the High Street, and it is not all about cutbacks in consumer spending. More importantly retail purchasing is changing. Consumers are becoming sharper shoppers by looking elsewhere, not just in the High Street.  They are visiting dedicated retail parks combining shopping and leisure to offer an experience, entertainment and convenience in one place and are also increasing their online spending.

The government has recently asked Mary ‘Queen of Shops’ Portas to take a look at the country’s High Streets and come up with suggestions for rescuing them, clearly hoping to find a way of rejuvenating this part of the UK economy.

She may well conclude that the competition from shopping and leisure centres with their easy access via car and public transport is too much and that the High Street can survive but only if it offers something different.

Locals still like to buy from local shops that provide a personal service, ideally selling local produce such as farm-sourced. This ought to support retailers like the grocer who lets you taste a piece of cheese before you buy, independent butchers who will advise, trim or even marinate meat and local bakers. Pubs, restaurants and cafes that cater for families, young people, the elderly all play their part in supporting community, even the self-help run library. But for the High Street to avoid further decline, everyone needs to work together and this will require leadership.

You never know, the High Street may be once again be a place where shopping is an enjoyable experience, but what will it look like?

Break Free from Servicing Debt and Invest in Growth

Britain lacks self confidence and suffers from inadequate education, risk averse bureaucrats and unimaginative politicians trapped in the Westminster bubble outside the real world.

Former CBI chief Lord Digby Jones identifies all these as obstacles to rejuvenating UK Plc in an extract from his book Fixing Britain. It’s a picture K2 recognises.

“Too much of Britain is focused on repaying debt and not on investment in growth,” he says. “Too many companies are servicing debt and existing for the benefit of the banks when they should be cramming down debt and pursuing a clear strategy.”

Lenders, more interested in loans being repaid than on growing their customers, are stifling businesses with potential by soaking up surplus cash to service and repay their loans.

In our view companies should return to being run for their shareholders and employees rather than for the benefit of lenders. Rescue advisers can help companies with debt restructure by renegotiating loans and interest, converting debt to equity or using a CVA to cram down debt.

We need to create a market-driven and investment culture, where profits are reinvested and appropriate tax incentives to encourage business investment.

The UK cannot compete as a low-cost manufacturer with countries like India or China and therefore businesses need to focus on high value goods and services requiring specialist knowledge to justify a premium. This is why high calibre education of young people and apprenticeships are needed.

First decline in household income for 30 years causes pain on the High Street

The Office for National Statistics (ONS) reported recently that in 2010 real household disposable income fell by 0.8%, its first drop since 1977.

A plethora of profit warnings from major high street retailers is therefore no surprise. JJB successfully agreed a new Company Voluntary Arrangement (CVA) for repaying debt, just two years after its last one. Oddbins’ attempts to agree a CVA were rejected which led to it going into administration.

Meanwhile travel company Thomas Cook announced a 6% fall in holiday bookings from the UK. Dixons announced that it was cutting capital expenditure by 25%. H Samuel and Ernest Jones, Argos and Comet all report falling sales. Mothercare is to close a third of its 373 UK stores and HMV has just sold Waterstones for £53 million to pay down some of its £170 million of debt.

Falling consumer confidence, the Government’s austerity measures and rising commodity prices have led to a steady erosion of disposable income. An April report indicated an increase in retail sales, up 0.2% on February’s, but this was attributed to non-store (internet) and small store sales and probably conceals a continued decline in High Street sales.

After a few years of expansion fuelled by debt, it is entirely logical that the marketplace is now facing a sharp contraction as consumers spend less money while they are concerned about their job security and repaying their huge levels of personal debt.

Many companies need to contract and reduce their cost base if they are to survive. For the High Street retailers this means concentrating on profitable stores and reviewing strategy.

Growth is likely to involve developing experience based retail outlets in dedicated shopping environments or direct sales such as online. The High Street has failed to reinvent itself and the recession has accelerated its decline.

The Current Conundrum Over Inflation and Interest Rates

The most recent inflation rates show that the Consumer Price Index (CPI) has risen to 4%, a surprise drop of 0.4% from February and the Retail Price Index (RPI) to 5.3%, also a fraction less than February’s 5.5%.

If times were normal these figures would nevertheless trigger a rise in the interest rate to 7 % to 8%, about 2.5% above the RPI.

However, times are still clearly not normal following the financial “tsunami” that was the 2008 Great Recession. Many businesses are still struggling to survive and grow in the face of reduced spending by consumers and clients and cope with soaring materials and commodity prices and volatile oil prices because of uncertainty over events in North Africa and the Middle East.

As a result the fear that an interest rate rise might push the economy back into a recession has led to interest rates being decoupled from inflation.  Inflation is a form of currency devaluation.  It means that every £1 buys less than it did when inflation was lower.  Interest rate rises help to correct this. 

I would argue that currently many businesses are operating with huge levels of debt and not doing all they could to reduce even though they can only survive because interest rates are currently so low.  But this current situation is only temporary.

While a viable business should be able to build a surplus of cash in this situation to provide itself with a cushion once interest rates start to rise again, a business in difficulty will not have this option. It therefore needs to think ahead and revamp the business model and restructure to survive and be ready for to what will happen when things are more “normal”.

Maghreb and Middle East Volatility Adds to Pressures on UK Business

Pressure on UK businesses is already intense as a result of the Government’s austerity measures designed to cut the UK budget deficit.

Already facing changes to NI payments, rising prices for raw materials as well as January’s increase in VAT from 17.5% to 20% and the dilemma of how much of these additional costs to pass on to consumers, now upheavals throughout North Africa and the Middle East are adding enormous uncertainty.  Oil prices have soared to their highest levels for two years, with impacts on all areas of the economy.

But it is not only oil prices that could add to business instability.  The UK is Egypt’s largest investor at around £10 billion, with around 900 UK companies involved, in

Tunisia exports from the UK in 2009 totalled £153 milliion, while imports were at £406 million, and trade with Libya is estimated to be worth £1.5 billion. British exports of goods to Libya were worth an estimated £1.29 billion in 2010.

The impacts will be felt on the UK travel industry, UK construction involved in building and infrastructure projects in Egypt and Tunisia but also on domestic services, for example Libyan-funded education in the UK of more than 6,000 students on undergraduate and postgraduate courses, worth an estimated £160 million.

I believe that, while businesses should try to hold their nerve, even those businesses that have survived so far without getting into difficulties might be wise to not only pay close attention to cash flow but also to revisit their business plans to put themselves in the best possible shape to be able to cope with the continuing uncertainty.

K2 believes the budget is positive for business and for those in difficulties

With the latest inflation figure showing an increase to 4.4% and a lower amount of tax collected in February, both announced the day before the budget was due, arguably the Chancellor had little room for manoeuvre.

There were some small comforts for smaller enterprises though the bulk of George Osborne’s measures are likely to benefit big corporations the most.

Cutting fuel duty by 1p per litre, and delaying a planned 4p per litre rise to April 2012 along with scrapping the fuel duty escalator was welcome particularly to hauliers, couriers and other companies that depend heavily on transport.

Keeping personal tax at its current level and increasing the personal tax allowance next year will also moderate any pressure on wage inflation, which is in any case not great given the current uncertainty over employment.

The money for apprenticeships, the new enterprise zones, the relaxation of planning laws and the new decision deadline should also make life easier for businesses.

However, I believe most of the budget’s measures are likely to benefit larger corporations, rather than the smaller, UK-focused businesses.

Overall this is a budget that doesn’t load yet more pressure on struggling businesses but the real concern among businesses is the prospect on interest rate rises which will squeeze those who are struggling to survive and precipitate a significant increase in the number of formal insolvencies.

Factoring and Invoice Discounting: Be Wary of Hidden Fees

Factoring and invoice discounting (borrowing money against invoices) can be a helpful tool for funding the working capital of a business.

While it used to be regarded as a means of borrowing by businesses in financial difficulties, it is now a common source of finance for managing cash flow and has the additional benefit of imposing discipline on the collection of outstanding sales invoices.

The service charge fee is pre-agreed with the finance provider and generally relates to the level of service provided. Fees for factoring are generally at a higher rate of between 0.8% and 3%, than for invoice discounting because the factoring service charge includes debt collection.

However, hidden in the small print are usually contingency fees that can be triggered by a default. These fees are sufficiently large to justify some lenders looking for reasons to trigger them.

There are many examples of companies in financial difficulties where the factor or invoice discount provider pull the plug on a facility and collects in the outstanding debts to recover funds loaned as well as their retaining the default and recovery fees.

Typical default fee are 10% of the ledger held plus recovery fees which are generally not specified. Such is the scope for earning fees that advisers to lenders might be persuaded to recommend the exercising of rights under a default knowing that they, as advisers, can be paid out of the recovery fee clause as well as repaying their lender client the loan and default fee.

Such self interested behaviour may swell the coffers of lenders but it doesn’t help preserve businesses or improve the reputation of the finance community.