Published on 18 October 2011 by Tony Groom

Many businesses are overburdened with debt and desperate for ways to deal with pressure from banks, HMRC and other creditors. All too often they are prepared to pay off old debt by taking on new debt which leaves them vulnerable to unscrupulous lenders.

In spite of the government rhetoric, most company directors know that banks are no longer prepared to take on the debts of others by refinancing existing debts. Whilst interest only loans and a reliance on overdrafts became a common method of funding prior to 2008, they relied on being able to renew facilities, or refinance them with new loans.

Like many interest-only loans, an overdraft is renewed, normally on an annual basis, it is also repayable on demand. What happens when the bank doesn’t want to renew the overdraft facility?  Banks are increasingly insisting on converting overdrafts to repayment loans and interest-only finance is disappearing.

This has created a vacuum for alternative sources of funding to enter the market where distinguishing between the credible salesman and the ‘snake oil’ salesman can be very difficult, especially when you are desperate to borrow money.

Rescue advisers are finding that many businesses just want to survive and are trading with no plan or in some cases no prospect for repaying debt. In such instances he argues that they should be considering options for improving their balance sheet by reducing debt. Options might include swapping debt for equity, or debt forgiveness by creditors or setting up a CVA (Company Voluntary Arrangement).

With the economic climate continuing to be volatile and uncertain, with banks under intense pressure to improve their own balance sheets, it is more urgent than ever for businesses to prepare and protect themselves with a credible debt repayment plan.

Many companies have survived while turnover declined by using their working capital to service debt. However this strategy runs out if the debt isn’t reduced since they run out of cash and can no longer pay suppliers and other creditors on the agreed terms.

In a recent example a service business was making a profit of £11,000 a month but had overdue liabilities of £150,000 of which £60,000 was owed to HMRC. HMRC had declined its repayment offer of £10,000 a month over six months and was insisting on £20,000 a month to achieve repayment over three months.

This company’s offer was in the first instance flawed as it ignored the remaining £90,000 of its debt.  It was in effect “fire fighting” by dealing with HMRC as the creditor that was being most insistent. Even if it had been accepted by HMRC, one of the other creditors could have easily obtained and enforced a County Court Judgement or Winding Up Order.

When businesses are desperate they often try to borrow money and become more vulnerable to what at first sight seem to be lenders that can offer them alternative funding solutions that the banks cannot.

Generally the advice is to beware, as the recent eight-year prison sentence handed to “Lord” Eddie Davenport illustrates.  He had set up a number of companies including Gresham Ltd, a seemingly 50 year-old and reputable company which had promised to provide commercial loans worth an estimated £500 million. In fact investigations revealed that the company had only been founded in 2005 and had charged clients tens of thousands of pounds for due diligence and deposit fees. A large number of business victims were promised loans that never materialised.

The charges related to a conspiracy to defraud, deception and money laundering and the court found Davenport and two others guilty in September. They were jailed but the case only became reportable in October, when restrictions were lifted.

Also referred to as “advanced fees fraud”, the deception caused unimaginable distress to the victims, many of whom found themselves with even more debt as a result.

Rather than turning to what may turn out to be dubious sources when the banks decline financing requests, businesses in distress should seek advice to develop a proper and manageable restructuring and repayment plan if they hope to have a realistic chance of survival. If it an offer of money looks too good to be true, it normally is.