TFG | Addressing the fundamental lack of available risk capital that can be applied quickly in a financially distressed business

Introduction

Objective

Having discussed the theory of turnaround finance, the section of this chapter aims to illustrate a practical work programme to assist raising turnaround finance.

It is written from the view point of a turnaround specialist advising a company requiring turnaround finance. However, it is equally applicable for the company’s management or existing providers of finance who may be assisting management to obtain additional finance.

Presumption of Distress

For the purpose of this chapter, it is assumed that the company undertaking the turnaround is actually or potentially financially distressed.

Whilst it is common place it is not the rule. For example, it is possible that an under performing company has excess cash resources, in which case turnaround finance is not an issue.

The Practical Reality: Raising Turnaround Finance is Hard

Raising turnaround finance is very hard because of the increased risks as addressed in the previous chapter, and the (normally) very significant time constraints.

However, it is important to stress that with a disciplined and focused approach it is very achievable.

Raising Debt is Easier Than Equity

In a turnaround; raising debt is considerably easier than raising equity. There are a number of reasons for this.

• Since the peak of the UK recession in 1992, there has been an explosion of secondary debt providers who specialise in “asset based lending” (ABL) to SME’s.The way the asset based lenders structure their security means that they focus on:
  • Specific assets such as debtors, stock etc
  • nterest cover rather than repayment as the facilities “revolve”.

This means that this type of finance is ideally suited for turnarounds.

An illustration of the growth of asset based finance GE Capital was established in the UK in 1998 with 4 people and no funds applied. By 2001 it had applied £500m of funds, and its employees had grown to 200.

What is especially interesting is the profile of the lending. The typical recipients of G E Capital funds have turnovers of between £10m and £20m and approximately 70% are turnarounds.

This type of financing simply was not available in the early 1990s.

In summary, asset based lending is available for turnarounds and very importantly appropriate for turnarounds.

• However, the reverse is true when it comes to turnaround equity – there is very limited turnaround equity available.The reason for this is that:
  • There are only a handful of equity providers in turnaround situations who are specialists in turnarounds.Of these providers, the nature of equity provision is that they do a relatively small number of deals every year.Therefore, a small number of equity providers doing a few deals each year mean that (relative to that demand for turnaround equity) there are a very small number of equity deals done.

    It is also crucial to understand that not only is it hard to raise turnaround equity but is hard to get a good deal without material dilution of the opening equity position.

  • There are nevertheless, many business angles, corporate investors and generalist private equity providers who may be keen to do deals.However, they are often not the best starting point when raising turnaround equity because:
  • • The distressed nature of the funding requirement can put many would be investors off.
    • The short and condensed time requirements are often too pressurised for a non-specialist.
    • This means that it is impossible for them to satisfactorily complete the transaction because of the due diligence requirements.
  • There are merits in approaching a financially strong trade competitor. This because a trade competitor can rapidly get into the guts of the business. However, extreme caution should be exercised when approaching a competitor as the competitor may use the distressed position as a “fishing trip” to hijack customers, employees and other key business intangibles.

If a trade competitor is to be approached it is important that it is for sound strategic reasons.