Looking after the rabbits

The last couple of years have certainly been a challenging time for business but, as FRASER CAMPBELL explains, relying on magic tricks is not the most advisable solution.

Over the last few years I have often felt like a magician, asked by clients to pull the proverbial rabbit from the hat to save them from the brink of financial disaster. This can mean some fleet footwork and creative thinking are needed to save the core of a viable business while cutting away the parts that are non-viable.

This can be an extremely painful process for all parties concerned, including creditors and banks. Once the various forms of restructuring, downsizing, rightsizing and refinancing are completed, a stronger business emerges and hopefully moves back to growth.

When an entrepreneur or company has been through this process they often realise, in retrospect, that they should have taken steps years, or perhaps decades, ago to protect their business from downside risk. In good times, planning for the day the family silver might need to be sold to keep the business afloat seemed unnecessary. In some cases the silver was sitting on a high shelf with a big sign, “property of XYZ Bank plc.” Any chance of flexibility to reconstruct sensibly was scuppered.

A key focus of my work now is advising clients on ways to look after the “rabbits” that are left after reconstruction and that are being created as we return to growth.

In all cases, advice centres on the simple counsel of keeping your assets in one pocket and your liabilities in another. In more technical terms, taking the example of property assets, these should, at the very least, be separated from trading businesses, either as part of the same corporate group or outwith the group entirely. This would allow a trading business to fail without the property assets being put at immediate risk. The same applies to plant and equipment that could be separated and placed in a leasing company within or outside a group.

This could also serve to strengthen a bank’s security position as separate entities ring-fence the ongoing revenue streams from the assets. It also allows a separate assessment of the level of debt that can be leveraged against those assets. Upon liquidation, assets are better protected and easier realised by a liquidator or shareholder if they are held discretely from a trading entity.

Increasingly, this approach is applied to intangible assets. We have seen several instances where, as part of a reconstruction, a company recognises the underlying value in their intangibles. This can extend from brands and trademarks through to software, innovative technology and know-how. Anything that can be separately identified, measured, commercially protected and used to generate an income stream through licence or similar arrangements can be valued and ring-fenced.

We work with specialist intellectual property valuers who can carry out a rigorous assessment of the value of intangibles. They use market data built up over time resulting from recorded sales of intangible assets.

Once valued, these assets can be placed in a separate entity from the trading business in the same way as property or other incomegenerating assets. Recognition of intangible assets poses unique accounting and audit issues. These must be considered carefully prior to entering into a transaction and on an annual basis thereafter. This ensures the asset remains recoverable and does not show any signs of impairment.

Tax consequences must be considered carefully. Depending on the assets recognised and the corporate structure, hidden tax traps can be triggered, even in a loss-making business. A suitably experienced intellectual property lawyer is crucial to the process to make sure the resultant transfer agreements and royalty or licence agreements stand scrutiny and are fit for purpose.

Once separated from the trading business, the organisation will secure an ongoing revenue stream from their intangible assets in a separate legal entity. This asset and income stream can be securitised by a bank and debt serviced from the ongoing revenue stream. It also means that in a distressed situation the intangible assets are readily marketable to third parties. They do not need to be extricated from a failing trading business.

Some banks are already adopting this approach to increase lending headroom. Positively, this is not just where they have identified a distressed situation but also where businesses are succeeding and growing.

This is an area that will continue to develop significantly. As professional accountants and bankers we must urge our clients to look after their “rabbits”.

Campbell Dallas LLP is a leading independent firm of Chartered Accountants in Scotland. The firm is the Scottish associate of UHY International. For more information or advice please contact Fraser Campbell on 0141 886 6644 or email fraser.campbell@campbelldallas.co.uk

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