Published on 8 July 2011 by Tony Groom
Many companies are being listed for sale through brokers with high price tags based on very tenuous valuations, where the owners have been deceived into thinking they will be paid a huge amount for their equity.
However, on closer inspection it turns out that many of them have a Time to Pay (TTP) arrangement with HM Revenue and Customs (HMRC), or are in arrears with HMRC and trade creditors. A great many of them turn out to be insolvent. This only tends to surface as a result of due diligence by an interested buyer and this situation is becoming a serious concern among potential investors who are looking at these companies on the basis that they might be a perfect fit with their existing businesses.
Realising that a target company for sale is actually insolvent leaves the investor struggling to see how they can protect their own interests if they wish to proceed with the acquisition or takeover, particularly if there is a risk they will contaminate their existing business.
Very often buyers, even those experienced in business, do not have the knowledge to assess the potential of a company even if they may be still be interested after carrying out due diligence.
The company for sale might be characterised by a failing TTP, creditor pressure, contractual obligations, asset finance agreements, onerous or unwanted leases, all of which have been ignored while the owners try to sell. Often owners are trying to protect their personal guarantees from being triggered as would occur in liquidation or an asset sale via pre-pack administration.
It is possible, however, for the potential investor to work with the incumbent directors to reach agreement with creditors and in doing so protect their own business from cross contamination or inter-company liabilities.
The traditional method of buying a business in financial difficulties is via a pre-pack administration. While this is promoted by the insolvency profession as offering a clean break that leaves behind creditors, it is rarely clean. Finance providers and suppliers are often common when the acquiring party is in the same industry. This provides scope for ransom demands against the acquiring party. Neither does it deal with employee liabilities that transfer under TUPE.
One way of limiting cross contamination is a share transfer with the buyer agreeing to invest conditional on approval of a CVA by creditors. The advantage is that the finance agreements and any liabilities remain in the target company such that these can be treated as creditors of the CVA. It also allows creditors’ issues to be addressed where they are not normally consulted in a pre-pack.
In addition to the commercial challenges, pre-pack administrations are being scrutinised following outrage by unsecured creditors. While there is no requirement to consult creditors the perception of abuse has put them under the spotlight. This may result in CVAs becoming more popular, especially as they involve consultation with creditors whose approval is needed.
Another consideration is the sales agent’s commission which can get in the way of a deal. If the agent is introducing the interested parties they will still expect to be paid an introducer’s fee, even if the company is insolvent. The fee is normally highlighted as a percentage of the sale consideration or investment but in the small print there is often a minimum fee which tends to be between £10,000 and £25,000 plus VAT.
This becomes an issue especially where the investor is not prepared to pay consideration for the shares in an insolvent company but instead offers to buy shares for £1 with view to injecting funds to save it.
Tony Groom, CEO of turnaround and rescue company K2 Business Rescue, argues that the owners trying to sell a business in difficulty should employ their own turnaround advisers. This will help the sale by having a turnaround plan in place rather than leaving buyers to work out how to save the business or more likely to walk away because they can’t see how to structure a deal that protects their interests.