Unified board vital for turnaround success

Insolvency rates in the UK are still remarkably low, reflecting the dangerous strategy adopted by banks to keep "zombie" companies alive. According to government statistics, there were 3,875 liquidations in Q3 2013, a 2.6% drop on the previous quarter and down 2% when compared with Q3 2012. To give these figures greater context, Q2 2009 saw more than 5,000 insolvencies. On an even longer term view, insolvency rates for the year ending in Q2 2013 represented 0.6% of total UK companies. In 1993, this figure was 2.6%, and the average has been 1.2% over the last 25 years.

This environment of decreased insolvencies is of course impacting dealflow for turnaround investors. According to unquote" data, despite an uptick in 2009 when 12 deals were closed, the UK over the last five years has been dismal for turnaround deals, dropping to just two transactions in 2013.

As well as the obvious reason behind limited insolvencies – banks playing Dr Frankenstein – the lack of deals in this space could also be attributed to some less conspicuous subtleties. According to John Dickinson, licensed insolvency practitioner and partner at CBW, the subdued activity in this space could be caused by attitudes towards turnaround investors and an understandable reluctance by special situations investors to acquire companies with internal disputes. "If a distressed business wants investment of any form, either working capital from a bank or equity from a turnaround house, first it needs to look at the balance sheet and projections. But it also needs a robust board – everyone must be united. From experience, there's often a little bit of tension on the board. Certain people want one thing, others what another."

Dickinson also notes there is typically a lack of trust concerning the motives of the incoming investor: "Shareholders will be asking if the investor is coming into the business purely to replace the bank and then put the business through a process." Much of these worries are likely to stem from board members having a significant investment in the business, which is at risk.

Furthermore, it is not uncommon for board members to have been through several rounds of restructuring in the past that have not worked. By that point board members may have a skewed idea of the business, believing it is worth more than it is and that it simply needs a bit more headroom from the bank. "In reality the business needs a clear out; it needs to rid itself of debt and remove pressure from creditors. But it can be difficult to see that," explains Dickinson.

Back to reality
Dickinson believes that boards in this situation need to regain a sense of reality and put themselves in the shoes of potential investors if a solution is to be found. "They need to rid themselves of their emotional ties to the business and to some extent to some of the history," he says.

Myles Halley, chairman of turnaround house RCapital, is no stranger to fractious boards: "It's inevitable that there will be conflict on the board of a troubled company." He believes that because of different roles held by board members – some with a stronger focus on the financials and some with more attention on sales and winning contracts – it is natural for each member to have conflicting views on the company. "There are always different characters on a board simply because of the different natures of their roles. There will be some that are optimists while the FD will always be more prudent."

Another constraint to turnaround dealflow could be investor selectiveness. "Turnaround investors are in a position to be picky; they need to make a return for their investors," says Dickinson.

With this in mind, why would a turnaround investor want to acquire a troubled business that comes with an extra layer of difficulty thanks to warring board members? According to Halley, as long as the company is not sat in a sector that is declining as a whole, then a divided board can be solved. "The adviser has a very important role to play; they need to bring an independent perspective and a sense of reality."

As well as assistance from the adviser in bringing the board back together, turnaround investors can find alternative solutions. "When the board is divided we look at who is crucial to the future of the business and get those people on side," explains Halley. However, if those people needed to ensure the company's survival can not come round to the turnaround house's way of thinking, then the business may well be doomed.

Thankfully there is increasing pressure on banks to clear out their work-out groups and tidy up their balance sheets, which should result in a wave of opportunities for turnaround investors. However, this surge of deals has been on the cards for several years and it will have to be seen to be believed. In the meantime, boards presiding over troubled companies could be doing a lot more to help themselves.

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• Topics
• UK / Ireland
• Turnaround/Special Situations
• RCapital
• United Kingdom
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