In our “Insolvency in the fashion retail sector: the risks and opportunities” article in the Q2 edition of Global Insight, we looked at the challenges the fashion retail industry faces today and the opportunities available for both existing players and new market entrants in the context of insolvent business acquisitions. In this article we comment in more detail on these opportunities and consider some of the factors and risks to be aware of when purchasing an insolvent fashion retail business and its assets.
OPPORTUNITY ARISES OUT OF ADVERSITY
The recent global financial crisis has seen consumers tighten their belts and the retail industry as a whole under ever greater pressure. Even companies with seemingly strong financial reserves and significant brands have found the market challenging - fashion retail has been no different. Profit warnings have peppered the financial pages (e.g. Mulberry), and other fashion retailers, within both the budget and luxury sectors, have been subject to formal insolvency proceedings (e.g. Aquascutum, Barratts and Republic).
For those fortunate enough to be in the position of the buyer, however, the current climate can give rise to considerable opportunities, including:
- The ability to cherry pick the business’ best assets without having to acquire its liabilities – for example the acquisition of prime retail sites and the ability to leave failing stores behind;
- Cost-effective market growth;
- The acquisition of direct competitors and key parts of their supply and distribution networks – for example, the acquisition of JJB Sports by Sports Direct;
- The consolidation of an existing business in the sector;
- The diversification of brands; and
- The development of a multi-channel offering – for example, by acquiring an online or catalogue function.
Understanding your industry, your competitors and their financial position is key to being able to take advantage of any opportunities that present themselves. An appropriately structured offer by a purchaser with an established link to or knowledge of the retail sector and an ability to move swiftly can prove attractive to any insolvency practitioner appointed to deal with the sale of the distressed business.
UNDERSTANDING THE PITFALLS
While the acquisition of a distressed business can present numerous opportunities and the ability to bolster an existing offering at an attractive price, any purchaser should proceed with a certain element of caution and make sure that they understand the nature of a distressed acquisition to avoid any pitfalls.
One of the most common ways of disposing of a distressed but viable business and its various assets is through an administration process. In broad terms, an administrator is an officer of the court with a duty to act on behalf of the creditors of the company over which they are appointed. Any such administrators will have limited knowledge of the business and the various assets. The information available to prospective bidders by way of marketing information is therefore much less comprehensive than in relation to a solvent sale.
Some of the key practical issues which should be considered by any prospective purchaser are set out below:
- Time is of the essence - Often any potential purchaser will be required to enter into a non-disclosure agreement when commencing negotiations in an acquisition. A distressed acquisition will often be completed in a matter of days (typically one to two weeks) from the point when the nondisclosure agreement is signed. While such tight timescales can be difficult to manage, in the fashion retail sector, where brand value and maintaining consumer confidence is key, a swift conclusion to the matter will limit any damage to the business and its brand.
- Cash is king - Administrators will prefer a party that is able to demonstrate ready funds and an ability to pay cash as opposed to reliance on bank or third-party funding.
- Due diligence - In order to structure an offer at the right level, you will need to understand the state of the business and what is on offer. However, the nature of a distressed sale limits the amount of detailed, reliable, current information available, regarding both the assets and the financial status of the business, and it limits the time available for review. The lack of information or ability to value the assets accurately, and, consequently, the increased risk for the purchaser, will typically enable you to negotiate a reduced price.
- Warranty/indemnity protection - A purchaser cannot expect the administrators to provide any warranties or representations (backed by indemnities or otherwise) in relation to the business or assets being sold, nor will an administrator incur any personal liability in relation to the sale. The administrators are under a duty to not knowingly mislead or provide false or inaccurate information. The buyer will, nonetheless, be obliged to pay the full purchase price without deduction or ability to claim for losses should difficulties present themselves post-completion. Again, the price payable for the assets should therefore take account of this.
- Non-transferable assets - Some of the assets of the business – for example, intellectual property and operating licences, leasehold interests or supply and customer contracts – may be non-transferrable in their entirety or require the consent of any relevant counterparty. The purchaser should therefore carefully consider the value to the insolvent business of such assets and whether its existing business would be able to operate without them. The need to negotiate with any third parties will inevitably impact timing and could delay completion. In practice, however, there are ways to deal with such issues (see further below).
KEY STAKEHOLDERS – WHAT IS NEEDED TO RUN THE BUSINESS EFFECTIVELY?
It is imperative that any purchaser has a clear understanding of the main key assets required to run the business effectively following an acquisition. It may not be possible for the vendor and its administrators to sell and/or grant access to such assets and a purchaser will invariably need to liaise with various stakeholders in this regard.
TWO OF THE KEY STAKEHOLDERS ARE:
- Landlords – The premises from which a fashion retailer operates are often key to the business, and any purchaser may wish to retain the ability to operate from well- established, landmark stores. Such premises are not always owned by the insolvent company and are often occupied pursuant to the terms of a lease. Such a right of occupation is invariably non-transferrable without the consent of the landlord. A purchaser is unlikely to have sufficient time available to formally negotiate with a landlord ahead of completion of the acquisition. The administrators may be willing to grant a purchaser a short-term licence to occupy the premises in return for the payment of an appropriate licence fee (usually in a sum equal to the rent and service charge payable under the lease). While a landlord would usually be entitled to object to the occupation of the premises by a purchaser of the business, landlords are often willing not to enforce their strict legal rights on the basis that the rent for any period of occupation is paid, and they are often keen to secure occupation of the premises by a solvent tenant.
- Suppliers – Clearly, a company’s suppliers can be critical to the day-to-day functioning of the business. When a company goes into insolvency, suppliers’ terms and conditions of business often permit them to take steps to protect their position – for example, by terminating the supply contract. Suppliers are often in a strong bargaining position vis-à-vis the insolvent company and any potential purchaser and can hold these parties to ransom if a continuing supply of goods or services is required. While the possibility of termination of critical supplies can be a great concern to a prospective purchaser – particularly, for example, if the supplier supplies branded goods critical to the business or an alternative source of supply is unavailable – there are a number of steps a purchaser can take to secure the continuation of supply. Among them:
- A transitional services agreement could be entered into for a short time post-completion of the acquisition. Under this agreement, the vendor and its administrators agree to provide or procure the provision to the purchaser of the service in question (such as stock management systems or electronic point of sale systems). This mechanism gives a purchaser the time to make its own arrangements in respect of the relevant supply or negotiate its own terms with the supplier.
- The purchaser could agree to make settlement payments equal in whole (or in part) to any outstanding sums owed by the insolvent company to a supplier in return for the continuation of supply of goods or services, or the release of goods by the supplier to the purchaser. This may be an attractive proposition to a supplier, as otherwise it would simply rank alongside other creditors of the company and would likely only receive a small “pence in the pound” return from the insolvency process, or
- If time permits prior to completion of the acquisition and a supplier is willing to cooperate, the purchaser could seek to enter into a novation of the relevant supply contract. However, a purchaser will often wish to negotiate its own terms with the supplier so may not feel that this is the most appropriate course.
While there are a number of pitfalls for the imprudent purchaser of a distressed business, those who are savvy and well-advised will be able to make the most of the opportunities offered in this arena.