Company Doctors - Casualties of a crisis
Firms are taking 'rescue culture' seriously, write Keith Bordell and Frances McLeman.
Firms are taking 'rescue culture' seriously, write Keith Bordell and Frances McLeman.
With the collapse of the Tiger economies, disarray in Russia, concerns over South America, and nervy financial markets, UK finance directors could be forgiven for admitting to a few sleepless nights.
Thoughts are turning back to the recession of the early 1990s, when high-profile corporate scandals (such as Maxwell and BCCI) and collapses (such as Olympia & York, Polly Peck and Ferranti) dominated the headlines, and financial difficulties and insolvency loomed large in the minds of those running businesses.
The scale of the economic crisis meant that the ‘work-out’ teams in banks could often only afford the time and effort to help the very biggest clients to avoid collapse by implementing a turnaround plan. Other businesses in difficulty often ignored their own problems or did not know how to address them until it was too late. All too often they faced little prospect but receivership if they encountered a slowdown in business, a major customer collapsed or there was insufficient cash flow to trade on.
Where banks were prepared to offer a rescue package, support was normally conditional on whole-scale changes in senior management.
Company doctors were brought in to plan and implement the rescue. Among others, ‘company doctor’ David James, CBE, took the helm at companies such as Eagle Trust and Davies & Newman (the parent company of Dan Air), and Sir Lewis Robertson at the Stakis group.
Well, here we are again facing, potentially, a domestic recession following global events. PricewaterhouseCoopers recently predicted a 40% increase in business failures over the next 14 months.
So what has been learned since the early 1990s? Is there now more of a rescue culture and, if so, who will implement it? A key question is whether the banks will have the inclination and the resources to help viable small and medium-sized businesses back to health.
A recession now would have different features to that of the early 1990s. For a start, the property market, while buoyant, is not at the frothy levels of the late 1980s; many commercial developments are pre-let rather than speculative. The global crisis means, however, that companies with direct exposure to Asia and emerging markets are likely to suffer.
These include investment banks and UK businesses which may become swamped with cheap imports of, for example, steel, toys, clothes or electrical goods from Asia.
Clearly, the banks will be keeping a close eye on customers with exposure in these areas, to monitor their positions closely. With forward planning and an increased recognition that facing up to problems early is in the interests of all concerned, it may be that, this time, the problems will be recognised, addressed and better managed by both businesses and banks alike.
But one thing is unlikely to have changed. Those companies with weak management teams that do not identify problems soon enough, and those which have experienced rapid growth but have poor internal control mechanisms, are likely to encounter serious difficulties first. This is where a greater rescue culture may have a big impact both in the bigger corporate crises and with SMEs – particularly if greater efforts are made to spot problems sooner.
So is there a greater willingness and capacity on the part of the banks to support business turnarounds rather than receivership strategies?
Andy Cumming, risk management director of commercial banking at Lloyds TSB, says: ‘The rescue culture is now firmly established within the banking sector, reflecting the general acceptance that a supportive approach is in the best interests of customers, the banks and their shareholders.’
Economic conditions in 1998 are very different from those of the late 1980s, and many businesses are better prepared to deal with the downturn.
Banks, too, learned lessons from the last recession, and we have worked hard to establish closer links with customers and to understand the different sectors in which they operate better.
‘Businesses are encouraged to approach us earlier and this, coupled with managers trained to spot the early warning signs of difficulty, means we can move quickly to give the business the best possible chance of survival. Banks must be satisfied, however, that the ongoing company is sustainable in terms of cashflow and debt serviceability and that the management is capable of driving the business through a period of crisis,’ Cumming adds.
It is interesting to compare the changes happening within the UK to the position in the US. The different insolvency regime in the US where, via the Chapter 11 procedure, debtors rather than creditors obtain court protection to allow them to remain in the driving seat in times of corporate crisis, means there appears to be a greater acceptance – on the part of the US banks – of a rescue culture.
Of course, to an extent, this acceptance derives from the differences between the UK and US legal structures. In the UK a secured creditor, such as a bank, has extremely extensive powers. US banks do not, unlike their UK counterparts, have the benefit of fixed and floating charges and the ability to appoint receivers very quickly largely to the exclusion of management.
In the US, business failure seems to be regarded in a less draconian way and with less stigma than in the UK – being almost part of a business learning process. Here in the UK, while the insolvency regime to a large extent leaves power in the hands of creditors, and particularly those with security, there has for some time been a move towards management and banks trying to solve problems in co-operation within businesses, rather than hiding the problems away.
So, if there is more of a rescue culture – who initiates the rescue? Experience of the early 1990s suggests that it is rarely the directors who do so. Often the last thing on management’s minds at the critical moment is taking the time to stand back and consider with their lawyers or turnaround accountants the options available to avoid insolvency.
Management is too busy attending to the business itself, fire-fighting day-to-day issues such as creditors pressing at the door and customers demanding to know what is going on.
It would be good if the lessons of the early 1990s were remembered by directors as seeking timely and appropriate advice may save the company and many jobs – including possibly those of its creditors who can be hard hit by the knock-on effect of a failure. Similarly, shareholders and trade creditors normally have insufficient information or cohesion to initiate a rescue plan. The banks, usually the most financially exposed to the crisis anyway, will usually initiate the rescue.
Commenting on the rescue culture this time round, company doctor David James says: ‘In past recessions, the pattern has been that major rescues have always started too late. This time round, the early warning system has to trigger more effectively and must include banks, shareholders and essentially, the directors.’
This will require a greater realisation by all involved that early warning signs, such as cash flow difficulties or problems with major markets and contracts, must be recognised early and dialogues between the board and its bankers commenced earlier rather than later. Proactive steps need to be taken to sort out the problem before it becomes a crisis.
How does the rescue come about? Normally, the first step is for the banks to require an independent financial review of the company and its prospects. If there is a business worth rescuing, the next step involves ensuring the appointment of appropriate, specialist advisers and, possibly, new management, which often begins with a company doctor or interim manager, to formulate and implement a rescue strategy.
This invariably involves the rigorous management of cash flow and, over time, the progressive reduction of debt, sometimes accompanied by a debt to equity swap or the sale of non-core assets or subsidiary businesses. Normally this is followed at a much later date by the sale of the core business itself at a sufficient price to repay the remaining bank debt and, if the rescue is very successful, to return an amount to shareholders.
The company doctor must retain the support of the banks during the rescue process. This feature of the corporate rescue process is still as fundamental to success as it always has been. What has changed is the people who are available to act as company doctors. Although some of the experienced, high-profile individual company doctors of the last recession are still available, and are in high demand, those with a track record to inspire confidence from the various stakeholders in a business are surprisingly few. It is not yet clear who will be the next generation of company doctors, although a number of the Big Five accounting firms have established turnaround, rescue and reconstruction divisions with specialist skills.
Lastly, what about SMEs in the next recession? Will they benefit from a more sympathetic approach from their bankers? Indications are that they will, and there also appears to be the political will to ensure they are given breathing space in which to seek to address financial problems. In his autumn statement, chancellor Gordon Brown announced a review, aiming to report within a year, of services provided by the UK banking sector including lending to SMEs.
The trends do seem to indicate a greater acceptance of the need for a rescue culture in the next recession. Clearly this will only be the case where a sound business exists, beneath the disarray caused by the disappearance of markets, a cash crisis or management failings.
But, if there is a severe global recession, will the banks have enough people in their work-out teams to co-ordinate rescues of varying sizes and in a variety of businesses, even assuming the will exists?
There is no doubt that prudent bankers – like prudent finance directors, are bolstering their internal procedures and resources to cope with recession – and checking that their best doctors will be available should the need arise. Frances McLeman and Keith Bordell are partners in City law firm Berwin Leighton