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

Mitigating the Increased Risk of Turnaround Finance

In recognising the increased risk of providing turnaround finance, specialist providers should take steps to mitigate these additional risks.

Each type of finance will require different mitigation steps. However, in general the following can be considered.

Planning

Due to the abnormal time constraints, planning is absolutely essential. In particular, in the planning of the process and people availability.

Pre-prepared Procedures and Pre-packaged Deals

For a financier or an advisor who specialises in turnaround finance it is prudent to have pre-prepared procedures in the following areas:

• deal investigation and assessment;
• deal structures;
• due diligence;
• legal templates.

The need for pre-packaging is necessitated by the time pressures involved in turnarounds. However, there is a limitation to the extent of pre-packaging as each deal must be specifically tailored to the facts of the deal.

Quality of Information

In all financing transactions caution should be paid to the quality and reliability of the company’s financial information. However, this is particularly important in the case of turnaround finance.

For example, it is common that when a company becomes distressed management are too busy fire-fighting to focus on producing quality financial information. Another extremely common example is where financial reporting is so poor that it may in itself have contributed to the company’s financial problems.

Therefore, particular attention should be paid to the company’s financial information, and additional due diligence steps should be taken to verify the reliability and accuracy of the information.

After the restructuring it is essential to ensure that quality systems, financial controls and reporting are maintained and/or implemented.

Additional Risk Assessment for the Turnaround

Additional risk assessment is required over and above a normal going concern investment. This should deal with the additional risk factors outlined in “Increased Risk” above.

Additional Negotiations

In normal going concern financing it is “usual” only to have to negotiate the finance deal with the directors and the shareholders.

However, in turnarounds the creditors are often more important than the directors/shareholders (although not always). It is therefore extremely important to identify:

• Which creditors are likely to take action and whether that action will have a material affect on the outcome of the turnaround.

  For example, this will include identifying:

  • If the company’s bankers with a floating charge will continue to support, or will the bankers make a formal demand and appoint an administrative receiver.
  • What outstanding judgements and winding up petitions there are?
  • Whether the landlord will exercise distraint.
  • The level of support of employees.
  • Which creditors are crucial to the ongoing trading of the business, and whether immediate non-payment will have an adverse impact on the company’s ability to trade?

Having established the importance of the relevant creditors it is important to consider them in the structure of the turnaround financing. How the creditors are dealt with will depend on the financial circumstances of the deal, and the quantum and character of the finance available. However, in many turnarounds, either management or independent advisors of the financiers will need to be involved in negotiations with the key creditors. This is peculiar to turnaround finance and is rarely required in normal going concern financing.

It is very important to stress that negotiations may take considerable time. Time is a luxury most turnarounds cannot afford. Therefore, it is essential to consider the negotiation time when structuring the proposed deal.

Identifying the Cause of the Financial Failure and Implementing Fundamental Commercial Changes

It is absolutely essential to identify the cause of pending financial failure and to implement a workable and realistic plan to prevent the failure recurring.

From the financier’s point of view this should be management’s responsibility and therefore should be included in the company’s business plan.

As it is such an important area, it may be prudent to ensure that failure to implement the agreed changes will result in default of the financing agreements. Therefore, this should be incorporated in the legal documents.

Maximising the Security and Security Cover

Given the increased risk of turnaround finance, it is important to maximise the security and security cover. This is consistent with the approach taken in going concern financing – however, in turnarounds there are additional issues to consider.

It may be that it is possible to rank ahead of existing secured creditors by creating a Deed of Priority or Inter-creditor Agreement between the new finance and the existing debt providers of the business.

Alternatively, it may be necessary to accept a position ranking pari passu with the existing secured creditor(s).

These positions will only be possible with approval of the secured creditor(s) concerned. This will involve negotiation. Furthermore, the deal clearly must accommodate the interests of the secured creditor(s).

Caution must be paid to ensuring that the taking of security does not create the possibility that the security may be subsequently set aside and declared voidable. The law relating to insolvency is complex and is discussed below. Therefore, specialist legal advice is essential.

Different types of finance may be more able to create full security cover. There are types of finance e.g. debt factoring, which offer security which normal traditional financing does not give.