As trading conditions get tougher and credit lines dry up, navigating the process of a business going into administration is becoming increasingly relevant to private equity firms. To some firms it represents failure: the equity is gone and the keys to what is left have been handed back to the creditors. To others, such as niche private equity firm EPIC Private Equity, which bought UK coffee retailer Whittard of Chelsea out of administration earlier this year, it represents deal flow.
In other – more controversial – cases, it represents both. In March, private equity-backed Rileys, the largest operator of snooker and pool halls in the UK, underwent what is known as a “pre-pack” administration. In a pre-pack, a buyer for the profitable parts of a business, which have been separated from the liabilities, is lined up in advance of a formal insolvency process. The business is then placed into administration for a nominal amount of time – often minutes – before being acquired. Pre-pack administrations are specific to the UK, but it is possible for businesses elsewhere in Europe to repatriate their headquarters to the UK to undergo the process.
In the case of Rileys, the vehicle that bought the business out of administration was backed by two private equity firms – Greenhill Capital Partners Europe and North Atlantic Value – which were the original owners of the business. The sale of the company to its original owners saved more than 1,200 jobs and 129 pool halls, said the buyers, although nearly 200 jobs and 30 locations were lost.
Greenhill and North Atlantic had backed a £35 million (€40 million; $52 million) buyout of the business 18 months prior to its administration. A smoking ban in the UK and changes to the laws governing high-jackpot gaming machines hit the business hard and it struggled to operate under an £18 million debt burden.
The potential conflicts of interest involved in the pre-pack process are stark. For one thing, there is the issue of valuing the assets for sale. The appointed administrator must be confident that no other buyer will offer better value for the business. If the administrator is acting correctly, the market will have been thoroughly tested before the sale goes through. But this may not always be the case.
“Sometimes management are repellent to approaches about their business when they are planning a pre-pack. We have certainly experienced that this year,” says Jon Moulton, managing partner of UK private equity firm Alchemy Partners.
Moulton also refers to an instance where a portfolio company became aware of a competitor in financial difficulty and made enquiries about buying the business. He was subsequently contacted at 11 o'clock in the morning by the administrator-elect to ask if he would like to acquire it. The deadline for his bid was set at 2pm the same day and no information was given.
As well as raising questions about transparency, pre-packs in which the existing owners resume control of the business have the potential to generate opprobrium among stakeholders. Those who lost jobs at Rileys may well be unhappy at the idea of the keys being handed back to the original owners.
In reality, however, concerns over the use of pre-pack administrations are normally aimed at the minority of cases in which a useful mechanism – albeit a vulnerable one – is abused. “Each story stands on its own: sometimes there is a real effort at market pricing, sometimes there isn't,” says Moulton.
Mark Dewar, a London-based senior managing director at restructuring advisory firm FTI Consulting, points to the example of Faith Shoes, a UK-based shoe retailer employing around 2,000 workers. Faith, which was bought out by private equity firm Bridgepoint in 2005, last year was facing an insolvency from which recovery from liquidation would have produced between 20 and 30 pence in the pound. “A pre-pack administration facilitated the sale of the business and assets and provided an opportunity to renegotiate some of the less appealing store leases. Importantly, the business survives today,” says Dewar.
At a time when most economies are contracting, there will inevitably be businesses that fail and stakeholders who get hurt. “Whether it's a pre-pack or not, someone will always lose something in an administration,” says Sion Kearsey of UK turnaround investor Kelso Place Asset Management.
Even if it could use a little tightening round the edges, a process that facilitates speedy intervention to rescue value and jobs can only be a good thing. I imagine the 1,200 employees at Rileys who kept their jobs would agree.