Funding a Turnaround

Raising business finance
A business turnaround is usually precipitated by a cash crisis and so funding a turnaround therefore usually involves two steps:

  1. managing the business’s finances so as to survive through an initial crisis and to stabilise the business; and then
  2. refinancing to fund the regrowth and future trading of the business.

At both points in a turnaround, lenders’ confidence in both the business’s management and its ability to meet repayments of borrowings out of future forecasts of cashflows are likely to be low given the business’s current situation or recent history.

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Funding for turnarounds therefore tends to rely on:

  1. whatever funds you can generate from within the business; together with
  2. asset based lending from sources whose principal concern is the value of the security available, at its most extreme on pawn broking basis and/or selling some or all of the business to specialist turnaround investors.

The focus of this ection is therefore on surviving an immediate cash crisis.

Wealth Warning

You must not simply use the techniques outlined in this section to obtain more cash, particularly by increasing borrowings or taking further credit simply in order to stave off an inevitable collapse.

You should seek to raise money to support a business in difficulties only if you have a real plan for turning it around which will involve making major changes in how it is operating.

If you simply put more money into a business without making such changes, or insufficient money to see the changes through, all you will be doing is simply sending good money after bad as the business will burn through the new cash introduced. But in doing so you may have actually worsened your position in that you may have:

  • converted your own assets, such as money held in a pension scheme into cash to invest into the business which is then lost
  • had to give personal guarantees for new borrowings; and/or
  • become personally liable for the business’s debts as a result of wrongful trading which is essentially where you took credit from suppliers and carried on trading after the point when you knew or ought to have known that there was no reasonable prospect of avoiding failure.

The purpose of this section is to help you to weather a cash crisis in order to put a turnaround plan, with some reasonable chance of success, into place.

If you are in a cash crisis and you have (or it would be reasonable to have) any concerns about whether there is a reasonable prospect of the business surviving, you must take professional advice to protect your personal position. If you are faced by a turnaround situation then you can find more guidance on all aspects of achieving a successful turnaround in Turning a Business Around published by How To Books.

The key questions in a cash crisis are:

  1. Is the company insolvent? Because if it is, whilst you do not necessarily have to cease trading, there are potential implications and risks of personal liability for the directors (which includes defacto and shadow directors) that can arise out of your legal duties on which you need to obtain advice.
  2. Does the company have sufficient cash for the immediate/foreseeable future? If not, you have just answered the first question.
  3. Will the lenders continue to support you? This may well determine the answer to the second question.

Is The Company Insolvent?

In principle, insolvency simply means that the company is unable to pay its debts as they fall due. Where a winding up is sought on these grounds, the Insolvency Act (1986) sets out four tests, failure of any of which is taken to prove insolvency:

  • failure to deal with a statutory demand
  • failure to pay a judgement debt
  • the court is satisfied that the company is failing to pay its debts where due (the cashflow test)
  • the court is satisfied that the company’s liabilities (including contingent and prospective ones) are greater than its assets (the balance sheet test).

Insolvency is important because if the company fails, a liquidator can potentially:

  • act to set aside some transactions made when the company was insolvent; and
  • hold you personally liable for the company’s losses.

Additionally, your responsibility for the insolvency will be taken into account when considering company director disqualification proceedings.

If you are not trading through a company but are acting as a sole trader however, you have unlimited liability for all your own debts (business and personal). If you are trading in a partnership, all the partners are liable together and individually for the partnership’s business liabilities (jointly and severally).

The moral is, when in doubt, if you are concerned about solvency, you should seek professional advice concerning your balance sheet position and your short and medium term cashflows. This advice may then enable you to legitimately continue to trade your way through while meeting your legal responsibilities.

Do You Have Sufficient Cash For The Immediate/Foreseeable Future?

To answer this you need a cashflow forecast. At this stage you usually need to concentrate on the short-term and prepare a forecast on a weekly basis for the next 13 weeks, but in extreme cases you may need to prepare one on a daily basis, covering only the next few weeks.

The cashflow forecast will be a vital document, for:

  • actively managing the cash to ensure survival
  • obtaining proper advice as to whether to continue to trade (to protect your personal position)
  • obtaining and maintaining bank support.

Cashflow forecasting is essentially straightforward as you are dealing with real cash movements into and out of your business, not more abstract accounting transactions, such as accruals, prepayments or depreciation.

For a weekly forecast, all you are looking to calculate is:

  • the cash you are going to get in that week
  • less the cash you are going to pay out that week
  • to give a net movement (flow) of cash into or out of the company.

Adding the net inflow (or deducting the net outflow) of cash to the balance held at the start of the week gives the balance at the end of the week as shown below.

Period 1
£000
Period 2
£000
Cash in 100 100
Less cash out (50) (125)
Net cash in(out)flow 50 (25)
Balance brought forward 25 75
Balance carried forward 75 50

The secret of cashflow forecasting is to keep it simple and to work methodically and logically down the page through all the cash coming in and going out of the business. You can now total all these to obtain your estimated total weekly inflows and outflows.

When preparing a cashflow you should:

Be realistic in your estimates of timings and amounts of cash and when in doubt, be prudent. Be pessimistic about when and how much people are going to pay you and when you are going to have to pay others.

Make your assumptions explicit. If your forecast assumes sales are going to increase by 20% next month because a new contract comes on stream then you should say so, otherwise lenders who may be looking at the figures may just think that you are relying on the new sales fairy to wave a wand and make this happen.

Experiment with sensitivities by flexing some of your key assumptions (what if sales go up by 5% instead of 10%, what if customers take 60 days to pay instead of 45?) to see how sensitive the forecast is to these fluctuations.

Think widely. Check that you have allowed for all possible payments that may need to be made by comparing the type of items you have allowed for with last year’s detailed profit and loss account and/or your old cheque books. Have you allowed for any unusual or one off payments such as corporation tax, redundancy payments, pension top ups, capital expenditure or repairs if any of these are likely to fall due in the period? Turnarounds tend to require professional assistance. Have you allowed sufficient to cover the accountants’, lawyers’ and bankers’ fees?

Finally, remember that you do not have a 100% reliable crystal ball. Build in a margin as a round sum contingency to allow for the things that will inevitably come crawling out of the woodwork. The more uncertain your starting point, the larger this needs to be, up to say, 10% or 20% of payments in some cases.

Part of the reason for cashflow forecasting is to build your lender’s confidence that you are in control of your finances. Having a contingency in place is not only prudent, but if it helps to ensure that you beat your forecast cash performance, it will also help to ensure that your lender’s confidence in your management skills will increase.

Once you have prepared your forecast on a prudent and realistic basis, you should then use what you have produced to plan and actively manage your cash on a day-to-day or week-to-week basis.

Compare the balance at the end of each week with the facility you have with your bank to see whether you have headroom or are going to be in excess.

If you are going to be in excess, plan what you are going to do about it. Look to see what scope there is for moving payments further back or bringing forward receipts. Speak to your lender in advance to agree a temporary extra facility. Use the cashflow forecast to explain why the excess will occur, how much it will be, how long it will be for, and how you are going to then reduce your borrowing to return to your normal facility.

Monitor your actual performance against forecast and where they differ ask yourself why, is this telling you anything that you need to take into account to improve your forecasting.

Will Your Lenders Continue To Support You?

The good news is that lenders will tend to support customers in difficulties where:

  1. the lender trusts your integrity
  2. you talk to them in time (and seem likely to continue to talk to them)
  3. you seem to be in control of your business (and its numbers)
  4. you have a plan
  5. the plan sets out clearly what support you need (how much, how long, how it is to be paid back)
  6. you are prepared to get in help where you need it
  7. the lender is confident your plan can work
  8. the lender is confident you can make it happen; and
  9. your plan does not materially increase the lender’s risk.

This last point is concerned with the current level of the lender’s security and the simple questions:

  • can the lender currently get out or not? and
  • how does your plan affect this ability going forwards?

A full estimate of a bank’s security position will be a complex matter, requiring specialist assistance in the valuation of assets and assessing reservation of title clauses.

For the purposes of most businesses simply looking at the position in respect of the two main assets of property and debtors provided a reasonable broad brush view of the lender’s position and should provide you with a sufficient basis to understand and discuss with your bank how confident or exposed they feel about your business. If your business has a significant value of plant and machinery you will need to add lines in for this as well.

By rolling this calculation forward based on your forecast balance sheet you can also see how the lender’s security position is likely to be affected by further trading. By discovering whether you are asking them to become more exposed or if your action will help them to improve their position, you can help to ensure their support.

So for example, a company may want to borrow more in order to fund making cost cuts and reorganising their product lines which will result in a short-term dip in trading. But then as a result of the reduced costs and newly organised sales working through, the company expects to be able to reduce its borrowings to give a profile as shown below for say a year.

Now Qtr 1 Qtr 2 Qtr 3 Qtr 4
£000 £000 £001 £000 £001
Property
Market value 100.0 100.0 100.0 100.0 100.0
Borrowings secured on property -70.0 -70.0 -70.0 -70.0 -70.0
Surplus / (deficit) 30.0 30.0 30.0 30.0 30.0
Debtors
Book value 150.0 125.0 150.0 150.0 175.0
At realisable value of say 70% 105.0 87.5 105.0 105.0 122.5
Borrowings secured on debtors (e.g. overdraft) -125.0 -150.0 -175.0 -150.0 -125.0
Surplus / (deficit) -20.0 -62.5 -70.0 -45.0 -2.5
Total surplus (deficit) 10.0 -32.5 -40.0 -15.0 27.5

The above example assumes all finance is through a single lender, such as a bank. Despite the projection that its position will have improved at the end of the year as a result of the plan, the lender will however clearly be concerned about backing this plan without some other security being made available, such as meaningful personal guarantees. This is because overall you are asking the lender to take a further £50,000 risk in allowing their current potential surplus of £10,000, which is the margin of safety they have that they can recover their borrowings if your business fails now, to a projected peak deficit of £40,000, before any insolvency costs.

Of course these days you may not have a simple single bank funding position and for many companies the debtors may be funded separately, by a factor or invoice discounter, from the lender providing a mortgage on the property so each funder will have to look at their own particular position.

The next section looks at how to manage a cash crisis, for detailed advice on areas of concern and access to a free 13 Key Steps guide click here for FAQs.

Click here for information on raising turnaround equity.

 

Information provided is copyright and subject to the Important Notice on the home page.

Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.

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