A pre-pack is a powerful business rescue technique that gives owners and managers of a financially distressed company a second chance; it saves businesses and on average secures employment for over 90% of the company's workforce. A pre-pack is an abuse of process, allowing the management of a failed business to deprive its creditors of adequate remedy and/or return. You can take your pick.
However, what is certain is that in the current economic climate its use is rapidly increasingly, to such an extent that the term ‘pre-pack' has entered into general parlance and the process is now receiving an unprecedented degree of public attention and scrutiny.
Reforms introduced in September 2003 have intentionally opened up the use of administration to small businesses. They remove the need for a court order and allow the directors of an insolvent company to simply file at court a notice which results in the appointment of an administrator over the company. The reformed administration process also represented an intentional shift in favour of debtors and away from creditors
In the vast majority of cases, once appointed, the administrator is likely to sell the business and/or assets of the insolvent company prior to any meeting of creditors. Indeed, the administrator may conclude that such a sale should occur immediately upon appointment.
A pre-pack is thus the short hand term used to explain the process whereby an insolvency practitioner buys the business and/or assets of an insolvent company on or soon after the insolvent practitioner is appointed as administrator of the insolvent company.
The use of the pre-pack has been seen in recent months in a host of different retail chains including Whittards, Karen Millen and Barratts Shoes and the successful rescue of these businesses can be contrasted to the administrations and eventual closure of Woolworths and MFI businesses. The very different experiences of these businesses highlight some of the problems encountered with trading administration.
This in turn explains why pre-packs, which offer a speedy and efficient way of transferring a business into new ownership with minimum disruption, offer significant attractions, especially to small and medium-sized businesses.
During administration the costs and expenses of the process, which include all of the firm's on-going running costs and liabilities, must be met through trading receipts and/or through third party financing. The finances of a smaller business may be more precarious; it is common for suppliers to withdraw any credit terms and customers to be wary of placing orders, all factors that cause chronic cash flow problems for the business in administration.
With decreasing orders the goodwill of the business may quickly dissipate during the administration process. To avoid the possible uncertainty of a prolonged trading period and maintain business value the administrator may well conclude it is in the interest of the company's creditors to sell the business as soon as reasonably practicable and avoid the risk of trading altogether.
Smaller businesses are more likely to be reliant on a core number of staff and management and the success of the business may rest on these individuals who could be lost during a prolonged trading administration period.
Such companies may have few tangible assets to be realised on a break up basis, perhaps because they are service focused, reliant on the knowledge experience and goodwill engendered by staff. The real value of the business resting in that intangible mixture of reputation, name and customer loyalty. As a result an early sale may maintain business value.
In approximately half of all pre-packs the sale is to existing owners and/or management. In reality this is unsurprising as certainly in the case of a SME, the business may have little appreciable value. The pre-pack offers certainty, control over the process and will result in the owner managers operating the ‘same' business through a new corporate vehicle, where they have rid themselves of the historic debt of the old company.
Some commentators argue that the process is so attractive, that it is being used inappropriately and this will in turn increase recessionary pressure, as more and more owner managers are lured by its easy charms.
However, while seeming to offer an ideal solution to businesses in financial difficulty, this has to be tempered. While empirical evidence is difficult to find due to short history of the reformed procedures it does seem to be emerging fact that a business ‘rescued' by pre-pack is statistically more likely to have a greater chance of future failure. Why is this?
The new company may find suppliers reluctant to trade with it again, or may find favourable credit terms have been withdrawn. Problems in obtaining debt funding will be even more so in the case of prior corporate failure. The reputation of the owner/managers may be sullied.
Lastly a pre-pack by itself does not address operational failings. Management need to take a long hard look at the reasons for previous failure and may need to shoulder responsibility. Simply ditching debt may not secure the successful long-term future of the business.
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