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.

HMRC Taking a Tougher Line on Debt Recovery

Evidence is emerging that HM Revenue and Customs is adopting a tougher approach to PAYE, VAT and tax arrears and increasingly using its powers of distraint to take over control of the goods, stock and assets of businesses.

In one example this week, just two hours after K2 was appointed by a company in difficulties, HM Revenue and Customs (HMRC) officers appeared at the premises and levied distraint on all the company’s assets and stock. There are similar stories from other turnaround and restructuring professionals.

The issue of a distraint notice (a C204 notice, also called a distress or walking possession notice), under HMRC powers allows it to take control of everything seized and while it does not necessarily remove property at that point, it means that the company cannot continue trading and is effectively put out of business because it is prevented from using its stock and cannot either sell or give away anything that has been distrained.  It normally has just five days to comply.

This walking possession is used rather like Winding Up Petitions (WUPs) when HMRC has exhausted attempts to communicate with the company.  Most companies are shocked when HMRC follows through with the actual action because it appears to come as a surprise, but when they review their correspondence they should not have been.

If the company does not pay or come up with alternative proposals, HMRC or an appointed agent can then take everything away for sale.

This hardline change of tactics comes after figures, published end of January, showed that the HMRC rejection rate for Time to Pay (TTP) arrangements had climbed from 2.7% in 2009 to 5.8% in 2010.

TTP is a very real solution for companies that cannot pay. While for the last two years HMRC has supported government policy of providing a light touch approach to businesses in difficulty, it is responsible for collecting arrears and not for saving businesses.

If a company receives a notice of intention to either wind up or distrain it should not delay in seeking the services of insolvency or turnaround advisers.

Will Project Merlin Make any Difference to Business Lending?

With so many companies in financial difficulties will many companies be able to take out further loans as a result of the new agreement known as Project Merlin?

The government last week announced that it had reached agreement with the UK’s four biggest banks to increase the amount of new lending to business in 2011 to a total £190 billion, of which £76 billion would be for small and medium sized businesses (SMEs). The SME portion is an increase of 15% on 2010.  

The lending to businesses will be on commercial terms that reflect the reduced number of lenders in the market. With bank base rates being so low, currently 0.5%, companies are being charged a huge premium with interest rates being set as 8 – 9% above the base rate. In addition, huge arrangement fees are also being applied, where fees representing 5 – 10% of the loan are not uncommon.

Many balance sheets are so decimated carrying huge liabilities to creditors such as HMRC, suppliers and asset based lenders (often at over value) that many businesses will not be able to justify a loan.

Business advisers, who see the effects of policy on the ground, say that one effect of Project Merlin will be for the banks to convert short term revolving facilities, such as overdrafts renewable daily, monthly or quarterly, into medium term loans. These will almost certainly be categorised as new loans in the quota reports but won’t actually represent additional, new funding. The banks continue to run rings around the politicians.

Converted loans are increasingly repayable on demand and therefore are being agreed on terms that allow the bank to keep all its options for essentially demanding immediate repayment.

Andrew Cave, of the Federation of Small Businesses, commented that the majority of small businesses were not seeking finance from the banks at the moment because the cost of existing and new borrowing is increasing and David Frost, director general of the British Chambers of Commerce, also cast doubt on whether the agreement will make any difference because of what he called the banks’ poor and opaque decision-making and over-centralised processes, with a lack of good frontline relationship managers locally in the banks.

Latest Insolvency Figures Suggest that UK Business is Hanging on in There

Figures from the UK Insolvency Service just released on 4 February 2011 for the last quarter of 2010 (Q4) show a decline in compulsory and voluntary liquidations, continuing a downward trend.

The total number of compulsory liquidations and creditors’ voluntary liquidations for the quarter to 31 December 2010 was 3,955 in England and Wales, a decrease of 0.2% on the previous quarter and a decrease of 11.3% on the same period a year ago. 

However, closer examination of these numbers reveals that there were 1,200 compulsory liquidations, up 5.8% on the previous quarter but down 9.9% on the corresponding quarter of 2009, while 2,755 creditors’ voluntary liquidations (CVLs), are down 2.6% on the previous quarter and down 11.8% on the corresponding quarter of the 2009. 

Compulsory liquidations are therefore showing a very slight upward trend after the previous two quarters, when they were down 3.2% on the previous quarter and in Q2 were down 9.9%.

A more interesting and perhaps pertinent comparison is with the figures from the last recession.

Either directors are doing a fantastic job of restructuring their companies to remain profitable with positive cash flow, which is unlikely when the word is that advisers from the insolvency and restructuring professionals are not busy.

The other possibility is that “companies are just hanging on in there” with support from creditors, including HMRC and banks, adopting a very light touch on struggling companies.

Companies should bite the bullet and undergo restructuring to survive as viable businesses. Until then, they will continue to “hang on in there”.

Is it Realistic for Private Businesses to Employ more Staff in 2011?

The majority of businesses in the UK are defined as small and employ fewer than 50 people while only one per cent of UK companies employ more than 1000 people.

Small businesses would generally be defined as having fewer than 50 employees, assets worth less than £5 million and a turnover less than £5 million, yet they account for two thirds of the UK’s private sector.

The Government is pinning its hopes of recovery on dramatically and quickly reducing the country’s budget deficit with a combination of cutbacks, including making an estimated 330,000 people in the public sector redundant, a figure revised downwards in November 2010 from its estimate of 490,000 the previous June.

This revision, albeit in human terms still a large number of people, is based on its forecast for growth in the economy in 2011 of 2.1% for all of which it relies on the private sector – the majority of which is made up of small businesses.

Economists and politicians are both emphasising that the opportunities for growth lie largely in increasing exports on the grounds that there is a burgeoning middle class in the fastest growing economies, like China, India, Brazil and Russia (the BRICS) with a growing appetite for sophisticated technology and household products.

But while this might be an option for businesses involved in manufacture it does not help those many small businesses providing services and products to local businesses and consumers in the UK only.

The UK manufacturing sector currently accounts for 26% of Gross Domestic Product (GDP) and the Government’s Department for Business, Innovation and Skills (BIS) published a White Paper proposing to expand adult apprenticeships by up to 75,000 by 2014-15 and to set up a new £50 million Growth and Innovation Fund, with financial support to SMEs to co-fund the costs of training for lower skilled employees.

Help with skills training by 2014-15 is hardly much use in 2011 and in any event growth will depend on being able to both increase sales and availability of finance from the banks to fund the additional working capital needed to support them.

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.