Eddie Pacey's credit casebook: Playing the long game

Veteran credit management expert Eddie Pacey recalls a case from the 1990s when he helped out a stricken system builder

Continuing a theme of business recovery case books, this latest one perhaps encapsulates a spirit that no matter how difficult things may outwardly appear, businesses can not only recover but go on to achieve significant impact and return.

The case in point was one of the most difficult I encountered and indeed was one of the longest on record, spanning almost 15 months from initial approach to clearance of the problems.

This particular case demonstrates admirably how experienced, knowledgeable and above all, empowered credit management can deliver not just simply bad debt avoidance but significantly increased profitable revenue streams and business continuity.

Adding a little background to the case book, I first visited this Midlands-based OEM in 1993. They were small employing fewer than 10 people and were focused on just one industry sector, that of education. Visits became a regular feature as business growth and demands on supply increased and the relationship became one in which they valued my input into performance and growth aspirations.

They had competition: several other local OEMs served the same industry and at one point some years later, our client decided to ‘merge' with another to, in the words of the director and owner, ‘stop us both cutting our margins to the bone'. The one negative for us was that we had historically declined credit to the other OEM for a number of reasons.

We had absolute trust in the ability of those running our client's business but were alarmed at the manner in which the merger was arranged. This resulted in increased visits and demands for additional information.

The merger arrangement effectively meant our existing contacts were responsible for marketing, selling, purchasing and production but senior personnel from the other OEM took over responsibility of finance and administration.

To say we were alarmed was an understatement and I insisted that on all matters my preference was to retain contact and meetings with directors I knew and trusted.

My first visit post-merger was some five months later having been provided with management information that looked overtly far too positive and out of sync with known performance of the two prior to merger.

On pulling into the car park, I could not help but notice a number of expensive BMW 3 and 5 series and at the front of the building a gleaming and relatively new Ferrari. There was certainly a buzz about the place and directors were cock-a-hoop with apparent performance. I actually teased the managing director about the Ferrari and the expensive looking cars but his response was upbeat insisting management information provided showed how well the business was doing.

On leaving, I insisted on being provided with monthly management accounts moving forward. I also quietly indicated my concern at management information provided. ‘Are you absolutely sure this information is correct and validated?', I asked. ‘I can see revenue increase given merger but levels and profitability appear too high too quickly'. He remained adamant all was fine and coming months and year end would prove it.

I managed to keep credit lines fluid by bringing in terms slightly and engaging on a twice a month payment cycle on 45-day terms in the run up to their year-end when my requirement was visibility of draft full-year figures and then of course fully audited results. We remained one of their principal suppliers.

Draft full year figures failed to arrive and some two months later, on forcefully making the request once more, I was assured figures would be provided but my usual contact, the managing director. He was out when I called in meetings with his bank.

The following month, I received a call. Not quite the one I was hoping for but nonetheless a movement of sorts. It was the managing director calling from his mobile. ‘I'm on my way down to see you with my bank manager who is now my finance director and I'll explain it all when we arrive' he said, interspersed with a few customary f-word expletives.

I arranged a meeting room and coffees and they arrived early afternoon. ‘Eddie you were right' he said. ‘I should have taken more notice but I've sacked the entire finance team and my bank manager has agreed to come on board as finance director to help me sort this out'. We're in a mess but I'm not one to give in and I really need your help and assistance to turn this around'. I'd not seen him so enraged and yet so determined to regain control and while the position looked quite bleak, I felt given support in some areas, we might be able to improve the company's position over time. It certainly would need the support of at least one major manufacturer, two other mid-tier distributors and on this occasion, credit insurers.

It transpired management had been fed ‘falsified' figures and coming off the back of these, a massive unwarranted explosion in costs and expenses had impacted. In working with his bank manager to create a more accurate picture of performance, draft financials suggested a hole in the balance of in excess of £1.5m, moving the company to an insolvent position and severely impinging cash flow.

For some extraordinary reason, the major manufacturer refused to support, placing further demand upon the distributors but mercifully, the credit insurer, on this occasion, and knowing the client extremely well, agreed to assist. It helped that the head underwriter for the electronics sector at the time was a young but extremely wise head and could see both the impact of no support and some support with a positive end result.

The first challenge was to convince us and others that the revised financial information showing the extent of the black hole in the balance sheet was accurate. Those supporting my request agreed to defer an element of payment due and use this to obtain a full independent audit by one of the top five auditing firms at a cost of £25,000.

The audit revealed the extent of loss was as indicated so the next task was to look at the requirement of product supply over the remaining busy summer period and how this would fit in to forecast business levels and cash flow planning.

It was never going to be easy but having viewed forward order books and sensible rational cash flow forecasts, we could see there was a chance to defer immediate payment of existing debt as much of it was current or only just payable while applying a separate arrangement for fresh orders placed.

Essentially, we worked cash flow with the company to ensure a weekly cycle of old debt repayment with normal terms applied to current transactions. Insurers would retain current cover as long as old or fresh debt did not age more than 90 days beyond terms. Monthly reviews would occur with face to face meetings to discuss monthly management accounts, forecast and cash flow. This was vital as the engagement of support was just prior to the summer hiatus of the company's activity.

Internally, I set up a fresh account to process new orders on terms agreed and froze the old account, allowing weekly payments to whittle it down over time.

If there was one thing that drove me to support this request and push others to assist, it was the make-up and constitution of the principle director and shareholder. He was likeable, motivated, knew his business and his customers inside out, was utterly trustworthy and spoke with a typical Midlands accent, with every sentence carrying at least one f-word expletive; not in a bad way but one borne of mutual familiarity over the years. It also helped to know that his business had been profitable, was profitable and could continue to be profitable.

Monthly meetings at their Midlands HQ became less intense as we worked through the programme of recovery and some six months in, the old debt was totally cleared and some nine months later, fresh supply was being paid in accordance to terms applied with no overdue debt evident.

The turnaround was astonishing. The hole of £1.5m in the balance sheet was almost totally recovered and the business once more became an efficient lean OEM servicing a sector it knew extremely well and in which it was highly respected, often winning deals against bigger, known vendor names.

It was further enhanced a few years later when the company was the subject of an MBO, funded largely by private equity. Price paid was in excess of £12m.

The owner justly elected to make time for himself and moved to Southern Europe after the sale and I once called him while he was enjoying a game of golf. We reminisced the difficult period and I guess celebrated the result and onward sale of the business.

As we were still one of the company's principle suppliers, I made arrangements to meet the new (but largely known) management team and also the non-executive director representing the interests of the private equity funders.

My fist visit post MBO was some three months after it occurred. We still had in place a structure that required quarterly management accounts and retained the same payment terms as before.

Management accounts provided for the first quarter post MBO suggested a somewhat subdued performance with lower sales and profitability but nothing outwardly alarming.

I met with the new general manager and finance director and also the non-exec. The message was very much upbeat but during the course of exchanges I could not help but form some doubt. Sales structure had not been correctly addressed and it became increasingly obvious the non-exec had astonishingly no grasp of what the business was about and where its core strengths had been.

The next quarterly results rung alarm bells again. Sales had declined more sharply and losses were once more evident and they were getting to be significant. Not a good sign when the company accounts are burdened by debt, amortisation, loan notes and rising interest charges.

MBOs are fine but there has to be an understanding of how much a business relies on those that have run it and what the impact may be of them moving away completely; more so if new management allows the euphoria of ownership to cloud judgement and lose control. Going without a sales director for months post MBO and not communicating with clients is a recipe for disaster.

As matters progressed, the original owner and minority stakeholder was forced to return for a couple of days a week to help ‘straighten things out' as he called it. Support from us on this occasion was less obtrusive or demanding but we were happy to oblige.

Within six months of him ‘straightening things out', the loss had once again turned to profit but there was an additional cost. Fresh capital was required and alternative private equity funders were found to take out the first.

The business survives, the original owner's interest no longer applies but there are lessons to be learned in terms of MBOs and indeed repetitive P/E funding.