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Why don’t more venture capitalists buy businesses out of insolvency?

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Insolvent businesses are a widely untapped market of potential for venture capitalists who could turnaround essentially sound, but ailing businesses and make a good profit. This opportunity has not gone un-noticed and a crop of companies have popped-up, like Better Capital which hit the news at Christmas when City Link collapsed, that are specialist “turnaround investors” looking for a bargain. 

In order for a deal to attract the interest of a venture capitalist (VC), there has to be some clear benefits for both sides: the vendor receives outside investment and the investor gets a return on his money. However, while this sounds simple and potentially, a marriage made in heaven for both parties, a vital part of the relationship is the engagement and, in many instances, this is by necessity a short one. Companies are often under severe financial pressure and there will be a temptation for directors to accept the first proposal that they receive. 

If there are numerous interested parties there may not be sufficient time to prepare a prospectus and have a beauty parade. Any business owner wishing to attract VC funding can only prepare the ground and supply sufficient information to enable the prospective investor to make an informed decision. 

With a few practical steps it can be easy to paint the business in the best:

Identify what went wrong and why

Businesses often enter insolvency because of one catastrophic event, like the loss of a contract or one poor deal. Frequently, the problems are caused by the aggregation of marginal losses and the financial equivalent of a slow puncture. Whatever the reason, you cannot expect anyone to invest in a failing business without first identifying the problem, devising a plan to address it and where the solution requires any expenditure, to have a budget.

Read more about insolvency:

Are there any skeletons hidden in the closet?

Nobody likes nasty surprises and you especially do not want a potential investor uncovering issues when carrying out due diligence or by asking relevant questions.
Where there are issues, such as claims from third parties that have not yet crystallised, bad debts, banks or previous financiers pulling the plug or employee claims, then you must be transparent in your disclosure. Many deals have fallen down due to employees’ rights under TUPE, even when buying from an administrator. 

Prove the company is worth the investment

First, you need to demonstrate the value to the investor. Remember most funders in this market are experienced and savvy. Why should they invest in a business which is heading towards failure when they could purchase it from the Administrator (perhaps more cheaply) when the axe has fallen?

When a business is bought out of a formal insolvency process it is not just a question of price. The purchaser is often able to free himself of the corporate structure, legacy debt and onerous contracts such as leases.

There may be real reasons that the integrity of the company should be maintained and restructured without a formal insolvency procedure and this needs to be made clear. 

Typically this will be centred on the contracted supplies the company is making. In almost every contract a termination event can be triggered by the institution of an insolvency process. Furthermore the novation of the contract into a new vehicle will inevitably require the consent of the other party and these negotiations can take time.

It is never too early to get financial information in order 

If you have a requirement for investment or finance for working capital then the sooner you start making the approaches the better. Control is a powerful ally whenever a business faces financial strife and when the creditors are beating down the door or the bank is threatening foreclosure you have either lost control or are just about to.

Having the correct Information

The provision and maintenance of up to date financial information and forecasts will assist any potential purchaser who will require comfort that this data will be available upon request whenever needed. 

Make sure management is on board

You need to demonstrate that the company has a unified, useful and committed board that possesses a license to drive the company forward again.

There is a perception that transactions of this type are rare and that there is little appetite for VC’s to take on insolvent or troubled businesses. Yet, this is not the true picture and there are an increasing number of funders who specialise in these types of deals. Bodies like R3, The Turnaround Managers association and The Institute for Turnaround can provide assistance to companies in this situation. A bit of preparation to present your business in the best possible light could make all the difference to attracting a VCs investor.

John Dickinson is a licensed insolvency practitioner and partner of chartered accountancy firm Carter Backer Winter.

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