The UK’s retail sector faces another “bloodbath” on the high street next year, according to insolvency specialists. They point to decreased spending and rising unemployment as reasons to expect a wave of administrations echoing the events of early 2009.

In spite of improving sales figures and a boost in sentiment, 86 per cent of insolvency practitioners polled by industry body R3 believe this year’s drop in spending will prompt the collapse of more retailers after Christmas.

Another factor singled out for the predicted disappearance of over 20 household names is creditors “biding their time” until after the peak trading period before they call in loans. January’s VAT increase is a further cause of pessimism for retailers.

“While it would be comforting to think that the worst of the downturn is over, it’s worth remembering that insolvency peaks after a recession ends,” remarked R3 president Peter Sargent. “We urge retailers to seek advice early when there is a better chance of rescue, rather than desperately clinging on, hoping that Christmas will cure all ills.”

In the opening months of 2009, around 22 high-street retail staples went into administration, including Woolworths, music outlet Zavvi, childrenswear chain Adams and tea and coffee merchant Whittard of Chelsea. For up-to-date information on businesses for sale and in administration take a look at our news section.

–>Latest retail businesses for sale.

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There has been a great deal of fuss in the press about the “pre-pack” administration process not giving a fair deal for the business’s creditors and accountancy firms benefiting in the form of high levels of fees. Despite many attempts by the industry to highlight the benefits of a “pre-pack administration”, it seems that the process is going to be looked at in detail by the Office of Fair Trading.

The investigation is aiming to look at fee levels and recovery rates, following concerns about what’s returned to creditors and how much the preservation of jobs in the insolvent business has cost. If the OFT finds against the larger accountants’ fee levels then it is likely there will be more work for the next tier of accountancy firms.

It looks as if the whole insolvency industry is going to have an interesting 2010. This is because business groups, such as the Forum of Private Business, have asked the OFT to delve into “phoenix companies” as well.

For those not familiar with the processes a “phoenix company” is simply a new company that has bought the assets of an insolvent company and carries on in the same trade as insolvent company, often with the same name and most, if not all, of the directors from the failed business.
Complaints against this process focus mainly around accusations that the assets of the failed company have been transferred out at below market price.

However, a “pre-pack” is a deal for the sale of an insolvent company’s business (and/or assets) which is put in place before the company goes into a formal insolvency process, usually administration. The deal for the sale of the business will usually have been worked out before the insolvency practitioner (IP) is formally appointed, and is then rapidly executed once the appointment is made.

The Office of Fair Trading’s senior director, Clive Maxwell, commented: ‘We want to identify any potential problems within the corporate insolvency market to ensure that firms and practitioners are competing freely and that the market is working well for the end consumers. Efficient insolvency services are an important component of a modern market economy.’

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Peter Harkness (above) and his business partner, Owen Davies, bought Highbury Communications, the North London-based publisher of many well-known newsstand magazines out of administration in 2006. The businesses downfall occurred after it had taken on too much debt – some £26m. This debt was mainly due to some disastrous acquisitions and the overly ambitious launch of new media products.

How Peter Harkness and his partner turned the company around so that it is now making a profit of £1m is an interesting story. The main focus was to get rid of the loss making magazines and concentrate on the “special interest” magazines that have a more loyal subscriber base. Due to the increased profitability of these new titles only 30% of the revenue now comes from advertisers. Profitability was further increased with the setting up of ecommerce websites closely linked to the actual titles.

Another successful entrepreneur, Simon Elliot (above right), saw an opportunity when the company he was interested in collapsed due to a £1m tax bill. Problems that were uncovered included a finance director who had been stealing from the company due to lack of oversight. One of the main attractions of the company were the long term contracts.

Both Elliot and Harkness found their target companies through careful research. Harkness says he ‘used to spend hours and hours downloading files from Companies House’, and Elliot’s successful bid came after two previous potential mergers had fallen by the wayside. Of course another great source of information is the Business Sale Report, where companies that have gone into administration are listed on the site each day.

Stuart Wilde just just saw a business, liked it and just bought it. Stuart was in the middle of a home renovation project when he found out his favourite supplier had gone under. Stuart was relatively wealthy but at 52 he had ‘itchy feet’. He jumped at the chance to buy the company, even though he had no experience in bathrooms or in retail.
‘I did question my sanity for a couple of minutes,’ he says, ‘but I felt there was a good business there, and the main reason it had gone into administration was because the previous owners had spent £750,000 doing up the showroom without thinking about cashflow.’

So what have the entrepreneurs learnt from their experience. A number of key lessons seem to have been learnt.

A more detailed version of this article where readers can gain more insight can be found by subscribing to the Business Sale Report

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Now that the ‘easy-credit’ party is over and businesses are facing uncertainty in the face of a faltering UK economy, there will likely be extraordinary opportunities for entrepreneurs to buy distressed businesses.

Recent figures released by the Insolvency Service reveal just how difficult the situation has become for some businesses. Between April and June this year, there were 3,560 liquidations, up 12 percent on the first three months of the year and a 15 percent increase on the second quarter last year. It also looks like the third quarter of this year will show a similar, if not higher, increase. Receiverships, often initiated by the high street banks and involving businesses that are at least three years old, have also more than doubled.

The Business Sale Report’s own figures show there were 2084 Administrative Appointments recorded throughout England and Wales in the first eight months of the year. This represents a 51% increase over the same period last year (1379). The industries most affected are property and construction. Other sectors suffering are those reliant on household discretionary spending including retail of white goods, furniture and leisure-based industries including travel, pubs and clubs.

Before venturing further, it is necessary to understand exactly what a distressed business is. The Insolvency Act 1986 (Section 123) sets out two primary forms of validation. The cashflow test. Where the business is unable to pay debts as they fall due; and the balance sheet test. The value of the business’ assets is less than its liabilities, taking into account its contingent liabilities and prospective liabilities. Obviously the degree of seriousness determines whether the business is liquidated or put into administration or receivership.

So why buy a distressed business?

Only buy a struggling business if you understand exactly why the business is currently in trouble, you know how to turn it around, and you have an exit strategy.

The one important myth to dispel is that the purchase of a troubled business is a bargain. The old adage that “if it looks too good to be true, it usually is” applies here.

Print film in a digital world…. many industries have a lifecycle that ultimately come to an end. If the product or service is no longer required at a level of need that enables you and your competitors to make a reasonable profit, why take on that struggling business and try to beat the odds?
Profitable investing in a distressed company is no different than investing in other types of business. It requires selecting a business, that once stabilised, has a demonstrable demand for its product or service going forward, for at least long enough to maximise your return on investment prior to or at your intended exit.
So you must do your research. Why is the business in trouble? Careful due diligence is absolutely critical in connection with a distressed business due to, amongst other things, the likelihood of limited or complete lack of recourse once the business has been bought.

So here are the important questions to ask:

• Is the business overburdened with debt?
• Are there any significant liabilities such as an adverse judgement or product liability claim?
• Are any tax losses available?
• Has the business lost key management?
• Are the company’s problems merely due to poor delivery or execution?

The ability to maintain the value of contracts going forward is essential. There may be restrictions on assigning contracts. Insolvency status may invalidate them and previous non-performance of contracts may incur penalties.

One of the main reasons that entrepreneurs buy businesses is the belief that they will be able to run the business better. So a buyer needs to be sure that they have what it takes to achieve this. The business may have been run poorly only because management time was taken up by a problem in the recent past so the current management are not incompetent, just distracted.

Of course, when buying a distressed business, ‘time is of the essence’, so it is important that you have a full team assembled so that you can go in and get all the information that is required quickly.
An entrepreneur has two possible methods of buying distressed businesses: either he or she can buy it to prevent it going officially insolvent, or else wait until the business is declared insolvent and buy it from the insolvency practitioner. There are advantages and disadvantages of both methods. We published an article on how to buy a business out of insolvency in the “September 2007″ edition, which you can access here. Here we will look at more general aspects of buying a troubled business.

How to find a distressed business.

A proportion of businesses up for sale are in some form of stress, as financial problems are often the catalyst that prompts the management to seek a sale. In addition to the listings here, you may consider contacting businesses via a trade association membership list, appropriate when a whole industry is in trouble i.e. estate agencies.
Specialist intermediaries are particularly useful if they also have considerable turnaround expertise. If you are known to them, you will usually be treated as an important buyer prospect, particularly if you have previously demonstrated the ability to act decisively and close a transaction in an efficient and timely manner.
Investors should be prepared to sift through many bad opportunities, and also accept that, for the good ones, there may well be a competitive bidding environment. If this happens, what, then, is the right price to bid? The “value” of a distressed company is often difficult to ascertain. The right price is going to be different for every bidder, because no two bidders:

• plan to run the business in the same way
• will effect a turnaround and stabilize the business in the same manner
• know how the business will integrate with the other businesses they hold.
• have the same cost of capital structure.
• have the same growth plans.
• share the same exit strategy.

In the current climate, where lending is drying up, the cost of capital is a key factor. Entrepreneurs who have large amounts of cash and do not wish to be highly leveraged are at a definite advantage at the moment.

So buying a distressed business can often have distinct advantages over alternatives. Start-ups always require more investment, in time and money, than is typically budgeted for. Moreover, there is often little or no track record of acceptability of the product or service. Profitable businesses have few reasons to sell other than to generate fast cash in excess of the net present value of the anticipated stream of the future cash. At the moment there are many owners of profitable businesses who are holding out for stretched multiples. So entrepreneurs who are keen to rapidly expand their portfolio of businesses interests would be advised to take a serious look at distressed businesses.
Another opportunity that cash rich entrepreneurs can exploit is the possibility that businesses might be divesting assets and divisions in order to improve their liquidity. According to Michael Garstka, a partner at Bain & Company, asset values are lower than they have been for a long time. “The downturn provides opportunities not just to acquire direct competitors, but also potentially key parts of your distribution networks or even choke points in your industry’s supplier chain.”

It is generally true that it is advantageous for the acquirer of a private company to purchase the assets not equity of the business for two main reasons – the tax advantages; and the fact that you will not be inheriting all the liabilities of the business. However, some assets still have liabilities attached to them such as contaminated land clean-up costs. Also, a purchaser may find him/herself exposed to intellectual property disputes on products. The entrepreneur will no doubt be under pressure from the seller to buy the entire company, but each situation is different and it is down to smart negotiation and good advice on structuring any deal.

In conclusion, if you have got what it takes to turn around a failing business, have cash in the bank or the ability to raise finance on good terms, then you are in a winning position. Cash is king. There are more failing businesses to choose from and fewer serious buyers in the market. This all leads to the prospect of rich pickings for a smart investor who is in a strong position in the market when the economy eventually picks up.

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