Business distress is soaring in the UK, as companies contend with the withdrawal of government support schemes, emergency loan repayments, rising inflation, supply chain issues and the end of restrictions on insolvency proceedings.
This latter factor has been the main cause of the number of UK business insolvencies more than doubling in Q1 2022 compared to Q1 2021. County Court Judgements (CCJs), meanwhile, have risen 157 per cent from Q1 2021 to Q1 2022, indicating that the long-anticipated post-COVID wave of insolvencies is well underway and set to continue.
Although worrying for many business owners, this trend also means that buyers have perhaps never had such ample opportunity to make distressed acquisitions. Furthermore, with the current climate of rapidly rising inflation making organic growth difficult, distressed acquisitions can provide the perfect alternative growth route.
In our insights, we often talk about the opportunities afforded by distressed acquisitions and how savvy buyers can use them to turn a struggling firm into a profitable one. But, of course, the actual process is far more complex and requires considerable amounts of hard work and knowhow. Here are some of the key steps for making successful distressed acquisitions.
Watch for the early signs
At times like these, there will be a multitude of buyers looking to make distressed acquisitions, so to take advantage of the best opportunities, it pays to be able to spot the early warning signs that a company is entering financial distress.
If a business is financially distressed it will start to experience regular problems with cash flow. This may mean it is struggling to pay rent or meet payroll obligations and will have a negative working capital ratio. At this point, the business is spending more than it earns and is firmly on the way to serious distress.
Following these early indicators, another major sign of distress will be action taken by the business’ creditors. As those owed money by the firm begin cranking up the pressure for repayment, creditor or debtor days may begin to rise and, if the company begins to default on payments, CCJs may be issued.
As creditor pressure and costs increase, the company’s margins will begin falling and, unless it steeply increases its prices in response, profits will drop.
Finally, look out for signs on the human side of the business. If a company is in distress then senior figures will likely be unhappy with performance and this could get passed down to junior staff, potentially resulting in an outflux of employees.
Set out a clear plan and move quickly
Of course, while distressed acquisitions can offer great opportunities, they need to be done in the right way, rather than just proceed with a scattergun approach. Buyers looking at distressed opportunities will need to have a business profile in mind, access to the right financing, the capacity to perform an effective due diligence process at speed and trustworthy professional advice.
Developing a profile of business you want to acquire involves asking some very basic questions, such as what sector are you looking at? What region or location are you looking to acquire in? And what kind of size of business are you interested in? Asking these questions and developing a detailed profile will improve the efficiency of the search process and save time that might have been wasted examining unsuitable businesses.
Having your financing ready to go will also be vital, as administrators or other insolvency practitioners will need to see proof of this in order to go ahead with any deal. Often, it will be the first thing they ask of prospective buyers and not having the funding or proof ready could mean they swiftly move on to others.
When it comes to due diligence, the time constraints of distressed acquisitions mean that buyers will not be able to perform the kind of thorough processes that they may normally be used to in acquisitions of solvent businesses. For that reason, buyers will need to be able to ask the right questions in order to quickly get as comprehensive a view as possible of the relevant facts.
When conducting due diligence for a distressed acquisition, consider how and why the business fell into distress and what its prospects are should you buy it. Are the problems internal or purely external? Will you be able to solve these issues as owner? Or are they so persistent that it may be beyond your capacity to turn the company around?
Throughout all of this (and given the high risk that comes with distressed acquisitions), it is highly recommended to get trustworthy professional advice. A lawyer or experienced M&A professional will be able to help with everything from selecting targets to due diligence and negotiations.
Getting these aspects of an acquisition strategy nailed down before looking for targets is crucial, not just for ensuring that buyers find the right opportunities, but so that they can act with speed when those opportunities come along. Given the time pressure administrators are under to sell insolvent businesses, being able to move swiftly will be crucial to not missing out.
In this exclusive, in-depth case study, we take a look at an example of a highly successful distressed acquisition: United Capital’s 2019 takeover of McGill & Co. While the acquisition began with a highly fortunate twist of fate, this deal demonstrates the importance of moving quickly, having a clearly established business profile and being sure that the distressed company can be returned to profitability.
From insolvency to profitability: United Capital’s acquisition of McGill
United Capital is one of the leading consolidators in the UK’s highly fragmented building and home services industry and has risen to its position of prominence through an acquisitive growth model that sees it target profitable, well-managed businesses.
Distressed acquisitions, then, aren’t United Capital’s stock in trade, with turning an insolvent business around not in accord with its primary acquisition strategy. However, when McGill, one of Scotland’s most prominent building services firms, entered administration on February 1st 2019, United Capital pounced on the opportunity.
Some fortuitous circumstances enabled the company to instantly put itself at the front of the queue of potential buyers and it quickly wrapped up a deal for the business. Three years later and McGill has returned to profitability under United Capital’s ownership, making it a textbook example of a distressed acquisition carried out in the right way.
Why McGill?
Given United Capital has publicly stated that its approach is to acquire and grow profitable businesses through buy-and-build strategies, the first question that comes to mind might be why it chose to acquire McGill, a hugely prominent, insolvent company?
In United Capital’s estimation, despite its distressed state, McGill still offered it the opportunity to undertake a buy-and-build strategy and, crucially, to do so in a sector that it had previously identified as fitting its investment model: the UK building services sector.
While the company had suffered from its share of external and internal problems, its prominence, established status in the Scottish building services industry and strong historical revenue meant that United Capital saw the business was viable, with clear demand and the opportunity to provide a platform in an attractive, fragmented market.
Ultimately, these factors meant that, when McGill fell into administration and its brand and assets became available at a heavily discounted price, United Capital saw an opportunity that it wasn’t going to turn down and moved swiftly in its efforts to acquire the company.
The administration
Founded in 1981, McGill grew over the years to become one of Scotland’s biggest building services firms. By 2016, the firm was a Scotland Top 500 Company and was generating annual turnover of around £60 million.
However, the company began to suffer as a result of challenging trading conditions within the construction sector, a situation which had the knock-on effect of causing late payments from creditors further down the firm’s supply chain.
During the winter of 2018 – 2019, these issues were compounded by a seasonal drop in work, resulting in the company seeing a significant shortfall in funding. Despite the company still registering revenues of £45 million and having developed a detailed turnaround plan, McGill’s directors were unable to secure the requisite additional funding to keep the business solvent.
As a result, the decision was made to place the business into administration on February 1 2019, with Blair Nimmo and Geoff Jacobs of KPMG LLP appointed to oversee the process of joint administrators.
The acquisition process begins immediately
To say that everything fell into place perfectly for United Capital to move swiftly to acquire McGill out of administration is an understatement. Firstly, United Capital had already attempted to acquire the business 18 months earlier, meaning that it had established a relationship with the owners and gained some insight into the company during a due diligence process.
A United Capital team, including M&A Director Leanne Carling (pictured above), were meeting with lawyers in Dundee’s Apex Hotel to discuss a property transaction on the day that McGill’s staff were called to meet with administrators in the very same hotel. This enabled Leanne’s M&A team to move immediately and steal a march on any potential rival bidders.
As Leanne explained to BSR: “All of the McGill staff were called to the Apex Hotel in Dundee to be told about the insolvency. By sheer coincidence, we were meeting our lawyer in the same hotel, discussing a property transaction. At our request, our lawyer engaged with the administrators immediately, and we were in pole position to be appointed as preferred buyer of the business.”
Over a four-week period, United Capital remained in constant, open dialogue with McGill’s administrators, with the regular communication ensuring that information flowed both ways and that the deal could progress quickly.
McGill’s insolvent state and United Capital’s desire to complete a swift takeover meant that there was a mutual interest in concluding the deal quickly. Leanne Carling said: “There are obvious time pressures on these deals and it is in everyone’s interest to move quickly, those we were committed to getting the deal done as quickly as possible so we could start rebuilding.”
Ultimately, United Capital successfully completed the acquisition of McGill on March 13th 2019, with the business having only fallen into administration on February 1st. At a cost of around £1 million, United Capital was able to acquire the assets, goodwill and business of McGill, including a commercial property owned by the firm in Dundee, using a mixture of existing shareholder funds and commercial bank finance.
Rebuilding begins
Despite the attractive acquisition price of the distressed business, as well its proven viability and potential, United Capital still faced a substantial rebuilding job with McGill, particularly for a business that typically focused on acquisitions of profitable companies.
To further complicate matters, all of McGill’s previous employees had been made redundant via the insolvency process when the firm collapsed, meaning that United Capital had to restart the business with zero employees.
If anything, this fact helped provide an element of clarity at the outset of the rebuilding process, giving United Capital an obvious starting point: a recruitment drive, starting with building a new board of directors from the best possible candidates. Getting this done early meant that United Capital had a strong team in place right away to lead McGill through the rebuilding process.
Alongside its recruitment drive, United Capital began a push to secure work for McGill, whilst also finalising its turnaround plan for the business and setting out some medium-term goals for where it wanted McGill to be a few years post-acquisition.
The turnaround plan
Any business that acquires a company out of administration will need to have a turnaround strategy laid out in order to convince administrators that they are the right owner to take the ailing firm forward. The takeover of McGill was no different, with United Capital developing a detailed strategy for how it would revive the company, alongside fully outlined goals post-acquisition.
United Capital’s turnaround strategy began with identifying the key issues that had led the company to fall into administration. External factors, such as wider issues impacting the construction sector and payment delays within the company’s supply chain, were obvious enough contributors, but United Capital needed to look deeper to get a true picture of the company’s problems.
This process enabled United Capital to identify several internal issues, that, along with external factors, had contributed to McGill’s insolvency. It found that the business had simply grown too big, leading to a lack of control. Furthermore, it was carrying too much overhead and had no clear plan in place for how to manage downturns.
Ahead of outlining its ultimate turnaround strategy, United Capital met with a wide group of stakeholders and reviewed McGill’s historical financial reports in order to get a clearer picture of the steps required to return the company to profitability.
United Capital’s rebuild strategy for McGill involved rationalising the company’s numerous divisions into just four key departments, enabling it to streamline operations and improve control. From there, United Capital carefully sought out and highlighted every inefficiency it could find within the business and modernised the company with new systems, before implementing strict fiscal control systems that would help to keep McGill’s finances in check.
Aside from merely focusing on the here and now, however, a core part of United Capital’s turnaround strategy was outlining some three-year goals for McGill. These were, to take the business to £20 million in annual revenues, to build a team of around 200 employees and to have McGill delivering profitable building services work throughout Scotland.
Post-acquisition
Since acquiring McGill in 2019, Leanne Carling says United Capital has delivered on the three-year goals outlined in its initial turnaround plan. The company is currently recording annual turnovers of £20 million and delivering profitable work to clients and customers across Scotland.
McGill has also provided United Capital with a platform from which to grow its building services operations and further M&A activity conducted through McGill has helped it to achieve this, as well as helping it to meet its ambitious three-year goals.
Regarding the company’s activities post-acquisition, Leanne said: “We always plan to grow via acquisition, since McGill was bought out of administration, there was always going to be organic growth, but we had ambitious plans and short timescales, so it was always going to be achieved via acquisition.”
“We have completed the acquisition of four other businesses in the same sector, three of which were merged into what is now known as the McGill Group.”
Having completed such a successful turnaround in the wake of this distressed acquisition, it might be tempting for United Capital to think “job done” and leave McGill to continue operating profitably and steadily as part of its wider group.
However, Leanne Carling insists that United Capital will continue to press ahead with growth plans for the company and says it has its eye on future acquisitions for the McGill Group: "We will continue to grow the group of business services businesses across the UK, ensuring the success of one business, can be leveraged for the benefit of the others.”
Conclusion
Distressed acquisitions are innately high-risk, with many possible factors that can go wrong. However, if buyers are well prepared, have access to the right tools, sound advice and ask the right questions during due diligence, then acquiring a distressed business can be an incredibly valuable investment.
Crucially, buyers will need to be certain that they have the tools and skills at their disposal to turn the business around. If, as in the case of McGill, the business is clearly viable and has strong historical demand for its service, then once it is stabilised, there should be a clear route to returning it to profitability.
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