What backers want to hear

It feels like many operators are no longer talking down the impact of the sector’s well documented headwinds on their businesses, but instead are taking real action to ensure their businesses remain profitable and viable. We’ve seen Prezzo, Byron and Jamie’s Italian all close sites recently and look carefully at their strategic options.

For many operators, the smorgasbord of challenges, including food inflation, wage increases, business rates and oversupply, is now starting to force their hands. On top of that, those operators whose businesses carry a debt burden (which will most likely be the case for those in private equity ownership) will be particularly worried about the current climate as they seek to preserve equity value and control of their own businesses.

Square Pie’s retail side went into administration this week, as further evidence of the ‘perfect storm’ of challenges facing the sector.

So what can operators and owners do to ensure that their lenders remain on-side during these turbulent times?

We’d start by observing that, in the current climate, many lenders remain supportive of their customers. Lenders recognise there are significant challenges in the sector – but also recognise that operators and shareholders generally remain best placed to tackle those issues, and to lead a turnaround strategy.

If stakeholders are engaged and supportive, operators stand the very best chance of remaining in control of their destiny

Notwithstanding a general culture of support, we highlight in this article a number of considerations that will help operators keep their lenders on-side.

The key for shareholders and operators will be to act quickly and decisively to stem declining business performance, whilst keeping lenders fully informed of the turnaround strategy. If stakeholders are engaged and supportive, operators stand the very best chance of remaining in control of their destiny and that of their business.

Shoring up the business

Operationally, the answer is likely to involve a combination of the below:

1. Disposing of non-performing sites

Some chains will be lucky enough to have sites in key areas (particularly in some areas of London) where a turn-key premium can be obtained for some sites that aren’t generating adequate returns. There remain new entrants to market (including from overseas) who are keen on securing new sites in established locations. Some operators will avail themselves of the opportunity to receive cash to bolster their balance sheets, helping to weather the storm.

2. Company Voluntary Arrangement (CVA)

For those under-performing sites where there is no possibility of a return premium on handing back the keys to the landlord, a more drastic solution may be found via the Company Voluntary Arrangement (CVA) mechanism. A CVA will allow the company to vacate its underperforming properties, close its branches, and in certain circumstances, vary key terms of existing leases.

The industry has already seen Byron successfully use a CVA to manage its estate. Some 99 per cent of creditors voted in favour of its CVA at a meeting on 31 January, surpassing the 75 percent of unsecured creditors by value needed to pass the proposal. The CVA divides Byron’s 67 leasehold sites and nine non-operational leaseholds into three categories: for 51 sites, the rent will remain unchanged, but Byron will now pay two-thirds rent at five locations, and a 55 per cent rent on 20 others. The arrangement for the third category will be in place for six months while Byron has crunch talks with landlords over whether to continue trading from these sites.

As secured creditors, lenders typically sit outside a CVA process, and consequently will generally be supportive if the CVA is part of a broader turn-around strategy, which may also include a financial restructuring. Lender “buy-in” is, however, of paramount importance, as proposing a CVA may trigger a covenant breach in an operators banking facilities which will need to be waived.

3. Discounting

Many operators will (if they haven’t already) be considering using discounting as a way of stimulating visits. Customers are squeezed, and it can be the idea of value that entices them to part with their hard-earned. That said, depending upon the level of their exposure, many lenders may worry that given a rising cost base, the additional spend from customers attracted by a discount won’t be enough to offset the squeeze on margin – particularly when there is interest and principal to repay on loans, and rent to pay. Real care should be exercised when deciding to discount – as it can define a brand during the good times, as well as the bad. Once taken, it is a decision that is extremely difficult to “row” back from.

Suppliers will have shared in the good times for casual dining - so sensible conversations in the current climate would seem reasonable

4. Suppliers

A number of operators will be speaking to suppliers to try and relieve some of the supply chain costs that have increased dramatically - in part as a consequence of the decision to leave the European Union, and the fall in value of Sterling against the Euro. Suppliers will have shared in the good times with the recent growth in casual dining in particular – so could sensible conversations be had here? We suspect so.

5. Talent

UK restaurant operators are heavily reliant on migrant workers (especially from the EU). Tighter immigration rules will make it harder for operators to hire staff, and increases in the National Living wage will increase labour costs. Savvy operators will prioritise employee engagement with a variety of training techniques and incentives, and where possible try to preserve margin through flexible staffing models.

Lender expectations

Lenders will want to see operators take the above into account when arriving at a clearly defined strategy to deal with the issues. In the ordinary course, lenders are likely to give their customers the breathing space they need to deal with any problems. But operators should always be mindful that the credit committees of those lenders will require their lending relationship managers to be spending time and effort to understand turnaround strategy.

Sometimes fees are required to support the work at those lenders, but most importantly if operators and owners grasp the nettle, engage with their lenders early, and come up with sensible solutions to the prevailing challenges, then there is every chance that their lenders will be supportive.

We wish everyone luck.

Partner Alex Dumphy is joint Head of law firm Addleshaw Goddard LLP’s Restaurants, Bars and Pubs sector.