Insolvency or bust!

Adrian Doble, head of restructuring at Vantis Numerica explains how entrepreneurs can avoid the stigma of bankruptcy and keep their business alive through restructuring.

Up 80% of new businesses fail, most within the first five years of operation. The grim realisation that even large, well-established, companies face the same threats makes high profile stories such as the failure of Parmalat in Italy headline grabbing news. But what of the individuals behind the headlines?

For UK entrepreneurs, the most likely route once cash flow has dried up and with the creditors knocking on the door, is to declare bankruptcy. However, while bankruptcy can relieve uncertainty and stress, it also has a stigma associated with it.

Directors may find it virtually impossible to raise future credit. In an increasingly complex market, directors have found themselves personally liable to the creditors of their companies. However, the alternative of business restructuring could mean that not only is bankruptcy avoided, but the business itself survives, at least in part.

Administration: a poor copy of US Chapter 11?

In the United States, bankruptcy is a tried and tested strategy for corporate restructuring. Some of the largest global organisations have successfully entered the protection offered by Chapter 11 and emerged intact, stronger and ready to compete. Delta Airlines is currently in Chapter 11 bankruptcy and is fully expected to survive at least partly intact.

Yet the UK's attempt to offer the same restructuring tool, the 2002 Enterprise Act, is a poor imitation. While in theory designed to save a company as a going concern, more often than not, in the UK, administration is a one-way road to company break up.

Indeed, given the structure of the Enterprise Act, it had little chance of success. In the America, directors retain operational control within Chapter 11, but in the UK an appointed insolvency practitioner takes control, and responsibility for trading the business moves to him, becoming his personal liability. His job is therefore more than often to recoup as much money as fast as possible. It is little surprise, therefore, that in the majority of cases the company does not remain intact but the business is sold off piecemeal to the highest bidders.

The other difference in the US is that because the expectation is that the business will survive, banks offer funding to assist ongoing trading. We don't have this in the UK.

Early intervention

Such attitudes are completely alien to US organisations accustomed to using insolvency to provide a safe restructuring haven. So, as North American investors flood into the European market, how will European companies cope as US-style restructuring processes begin to be put forward as a credible legal framework but as yet fails to offer the same level of benefits to the company and its board as it does in the United States?

If UK and European organisations are to weather the predicted market downturn in 2006, they need to take a far more proactive attitude towards early intervention when things go wrong.

The answer is simple: without the strong protection offered by Chapter 11, business leaders need to be brave enough to recognise the warning signs and accept operational restructuring professionals outside of insolvency. These are the companies that will survive.

When to do it

In up to 90% of restructurings, most of the effort concentrates on the financial reconstruction - including debt restructuring - to keep the company solvent. Yet this fails to address the underlying operational problems that have contributed to the crisis. It is operational restructuring - change management skills such as closing manufacturing facilities or transferring skills to improving quality or outsourcing - that is the key to the long-term survival of organisations.

To be most effective, an operational restructuring is best conducted within a solvent business, preferably in close collaboration with the primary creditors. Waiting for a company to hit a cash crisis is too late. A business needs "headroom" in which to operate.

Into 2006 together

The banks and accounting profession are committed to improving company rescue. The trade association, the Society of Turnaround Professionals, was born out of the big four insolvency firms and designed to promote the rescue culture and provide the early intervention needed to prevent organisations from entering liquidation and handing over control to an insolvency practitioner.

Early action

Early indicators of potential trouble are becoming increasingly sophisticated. Banks watch "account behaviour" very closely (such as the balance deteriorating month on month). Trade insurers run credit circles and monitor defaults very closely. Systems such as Company Watch are remarkable predictors of failure.

The techniques for mapping company performance are widespread and they are being used not only by banks and credit rating agencies but, increasingly, by hedge funds and bond holders looking to invest in European opportunities and buy up debt.

Without aggressive early intervention, however, including the use of turnaround experts to oversee an increasingly complex range of issues, organisations will continue to pay more for restructuring the closer they get to insolvency, many under the misapprehension that their relationships with their banks will see them through or that the Enterprise Act will enable restructure.

If directors knew the true costs of intensive care, versus the cost of early intervention and remedial treatment, then the introduction of experience based turnaround professionals would be simple. Sadly, hope reigns eternal and many see too late the folly of their ways.

Early intervention can be a tough decision, especially if a company is still making a profit, albeit a declining one. But the facts are clear: if insolvency is to be avoided the future should not be about crisis management. Too often this will result in a company entering bankruptcy and being broken up. Instead, it is about profit improvement through timely operational and financial restructuring of a still solvent organisation.