Funding a Turnaround

A business turnaround is usually precipitated by a cash flow crisis and so funding a turnaround therefore usually involves firstly managing the business’s real cash flow so as to deal with the initial cash flow forecast problems and survive to stabilise the business; and then refinancing to fund the regrowth and future trading of the business.

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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. Funding for turnarounds therefore tends to rely on:

whatever funds you can generate from within the business; together with

asset based lending from sources whose principal concern is the value of the security available, at its most extreme on pawn broking basis.

The focus of this article is therefore on surviving an immediate cash crisis. The type of funding you will need to raised to finance the business’s future development will depend very much on the nature of the business and your plans for it.

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 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 article 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. The key questions in a cash flow crisis are:

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.

Does the company have sufficient cash for the immediate/foreseeable future? If not, you have just answered the first question.

Will the lenders continue to support you? This may well determine the answer to the second question.

The first question to ask in a cash crisis then is whether the business meets an insolvency definition as if it does, it will need insolvency help.

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 cash flow 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 cash flow 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.

Cash flow 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. When preparing a cash flow forecast:

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. 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. Will Your Lenders Continue to Support You? The good news is that lenders will tend to support customers in difficulties where:

the lender trusts your integrity

you talk to them in time (and seem likely to continue to talk to them)

you seem to be in control of your business (and its numbers)

you have a plan

the plan sets out clearly what support you need (how much, how long, how it is to be paid back)

you are prepared to get in help where you need it

the lender is confident your plan can work

the lender is confident you can make it happen; and

your plan does not materially increase the lender’s risk.

Where a lender has concerns about a business and their security position they will often instruct an independent business review from an insolvency practitioner, or very occasionally, one of the turnaround firms. Bank security is concerned with the simple questions:

can the lender currently get out or not? and

how does your plan affect this ability going forwards?

Essentially a lender’s security will be the assets over which they have taken a fixed or floating charge with which to secure their loans to the business, together with any supporting security held such as a personal guarantee from a director or shareholder. Normally a bank will hold a debenture from a company for its borrowings giving:

a fixed charge over property, and sometimes over major items of plant and machinery, under which the company is unable to sell the specified items without the lender’s consent and under which the lender receives payment first from the proceeds of sale if they are ever realised; and

a floating charge over everything else in the business, including its receivables, which will then crystallise to catch the value of everything that the company owns at the moment of any insolvency, under which the lender will get paid out after certain other claims are met.

A full estimate of a lender’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 however, simply looking at the position comparing the realistic realisable value of the property, and the likely realistic recovery that might be expected from debtors in an insolvency, should provide a reasonable broad brush view of the lender’s position. If your business has a significant value of fixed plant and machinery over which the bank has security, you will need to add lines in for this as well.

This can then allow you to understand how confident or exposed the lender will feel about your business. 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.

This assumes however that all finance is through a single lender, such as a bank and of course these days you may not have a simple single bank funding position. For many companies the debtors may be funded separately, by a factor or invoice discounter, while another lender may be providing a mortgage on the property and a third finances the plant and machinery. In these cases each funder will have to look at their own particular position.

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