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A healthy business with a debt problem – is there a way out? (Part 2)

21 October 2010

What do you do when you run a robust, healthy business with a strong sales pipeline and a highly competent management team, but for reasons beyond your control you have a serious debt problem? Is there a way out of a cashflow crisis or does it spell the end of the road?

As the UK moves slowly and tentatively out of recession, albeit under the cloud of a threatened double-dip, there is no shortage of businesses that are experiencing cashflow problems. For some, a cash crisis is down to poor financial controls or an unsustainable business model, but this can hit an otherwise healthy business through no fault of its management.

In this, the second part of our series looking at healthy businesses with debt problems, Nick O’Reilly discusses the number of funding options management can consider, if the company is unable to steady itself financially by speeding up collection of other outstanding debts.

Additional funding available to businesses

Finance for businesses, SMEs in particular, is never far from the news agenda. The banks assert that, despite a freeing up of capital, they are not seeing the same demand for finance. Figures from the British Bankers Association show that loans to businesses totalled £598m in June this year, £269m less than June 2009. The Enterprise Finance Guarantee scheme, designed to help businesses fund growth, also runs until March 2011 and the government has committed up to £700m in support for viable small businesses.

The key to approaching the bank, which is very likely to be an existing funder, is to seek advice from your accountant to make sure the approach is professional and accompanied with strong, transparent financial and cash forecasts.

If the debt incurred by the company is such that an approach to the bank is unrealistic given an existing arrangement, there are other methods of funding available. Asset based lending can help a business to correct a cashflow problem by freeing up capital held in company assets, such as plant, building, machinery or stock. Alternatively, if a service-based business, invoice finance provides finance against the company’s debtor book. In considering any alternative funding method, it is wise to seek the advice of a specialist adviser, who will be able to source the most appropriate finance provider to suit the business’ needs.

Merger or trade sale

Another route to securing additional finance is to merge or sell the company with/to a competitor or synergistic business. This is a very realistic option for an otherwise healthy business with a visible sales pipeline. However, clearly it fundamentally alters the make-up of the company and so must be considered carefully, taking into account the interests of all stakeholders. Again, before embarking on this route it is essential that management consults with an adviser, who will be able to help determine if it is the right path for the company and, if so, provide the necessary corporate finance guidance to ensure the best deal is secured.

Company restructure or turnaround

An option that will not alter the business as an entity so drastically as a sale or merger, is a company restructure or the use of a turnaround specialist. A turnaround or interim manager will sit alongside company management for a fixed period of time to guide the business through the restructuring process. This process will be designed to lessen the burden of the debt on the existing business, to make sure the company is able to continue to trade and, crucially, is able to grow in the future. A company restructure will inevitably involve cost-cutting and this, unfortunately, can mean redundancies. These are very tough decisions for any management team, but to put the company in a position where it can continue to trade profitably, or even to a breakeven point for a short period of time, the costs must be aligned with revenue.

What if there’s a delayed reaction?

If a management team reacts quickly to a business-critical event that severely damages cashflow, it is highly likely one of these options will allow the company to trade through the problem and go on to recover and grow. If however, as unfortunately is too often the case, the problem is ignored, it very quickly spirals out of management’s control. A serious debt issue can rapidly result in a company trading while technically insolvent, if ignored. It is then only a short step before a disgruntled creditor, often HM Revenue & Customs, initiates insolvency proceedings as result of unpaid debt.

Even at this stage, if professional advice is sought early enough it is possible to avoid going into administration. Often, through open and transparent discussions with creditors, recovery advisers are able to negotiate extended payment terms before any enforcement action takes place.

If the company is forced into administration, it does not necessarily mean the end of the road. With an otherwise strong business, recovery professionals are able to market the company and often secure a trade sale. Some advisers are adept at trading a business through a difficult administration period and then achieving either a trade sale or a management buy-out of the business. Both of these outcomes can provide the best return to the former creditors, as well as affording the business a long term future for its owners and employees.

What if there’s no reaction?

For an otherwise healthy business to fail because of a bad debt, the management team would have had to have buried their heads in the sand and refused to acknowledge or deal with the cashflow problem. This is highly unlikely, as a healthy business will, by its very definition, have a strong management team. Our experience is that if advice is sought early enough, it is very possible to save a company where the only symptom is a bad debt.

For more information about any of the topics discussed in this article, please email us using the online form below.

[Click here to read PART 1 of our series, where we look at the signs that your business is in trouble and discusses what you should do immediately, once these signs have been identified]