Unravelling the pre-pack process

Jon Moulton can normally be relied upon to sum things up succinctly. Not one to shy away from sticky issues, the head of Alchemy – the majority owner of Inventive Leisure, Tattershall Castle Group and about 20 other businesses – recently gave his take on the practice of so-called “pre-packs”. “There is legitimate reason for concern,” he said “Some pre-packs seem to have a reason; others feel more like a stitch up than an administration.” The pre-pack process, which has been widely applied in this sector and looks certain to be a feature going forward, sees a sale of part or all of a business negotiated prior to the appointment of administrators. The distressed or over-levered business is then dropped in to administration and the sustainable bit – the Good Co – is bought out immediately through a new vehicle, free of some if not all of its previous debts and liabilities. The rest of the business – the (let’s be polite) Bad Co – is left with administrators. In the case of the eating and drinking-out market that normally means loss-making sites. A clutch of companies have been subjected to the pre-pack process. Laurel emerged from it as two separate companies, Bay Restaurant Group and Town & City Pub Company, while Herald Inns & Bars came out the other side as Cougar Leisure. Most recently Orchid underwent the same sort of surgery. It dumped onerous leases, dialled down its debt by undertaking a debt-for-equity swap with its banks, and emerged as a seemingly “whitewashed” freehold pub company with the self-proclaimed intention of consolidating the market. Even Tom Aiken, the high-profile London chef, has been through it, allegedly leaving suppliers significantly out of pocket. Clearly it is creditors that are left with a huge headache. The ones most obviously impacted by pre-packs in this market are landlords. After years of spiralling rents they face the stark choice of dramatically lowering the rent in order for their site to make it into the Good Co, or risk finding a taker on the open market. And it is hard to feel sorry for them. That would be like feeling sorry for traffic wardens or lawyers. Or journalists. But many small and medium-sized businesses are also being hurt. I heard of one cleaning contractor to a London-based business that suffered irrevocable damage as a result of a pre-pack. These various applications in the face of a sharp downturn have blurred the line between the pre-pack process being a genuine tool for business recovery and simply a get-out-jail-free card - a "stitch up" in the words of Moulton. Now there is talk of an overhaul of the rules. This is significant as it feels like a necessary restructuring of businesses across the sector has barely begun. Many businesses in the sector that were the subject of a leveraged buyout in the past two to four years need to take action. Stuffed full of debt, they were set up to deliver handsome returns in the good times. Unfortunately that means now they appear to be set up to fail in the not-so-good times. In many cases these are very good businesses that are just wound up too tightly with debt. They are perilously close to, or in breach of, their banking covenants. The issue has prompted the British Venture Capital Association (BVCA), the private equity industry’s trade group, to organise talks with representatives of the banking community this week, including Barclays, Lloyds and Royal Bank of Scotland. The BVCA hopes to engender more of a partnership approach and a rescue culture, one that can benefit both bank lenders and buyout investors. For an industry that throws off cash and is therefore able to cope with leverage, the “right-sizing” of debt structures is undoubtedly one of the key issues of 2009. Buyout investors will be forced to put more cash into companies and we will see more banks swapping debt for equity. But how much longer the nuclear option of pre-pack is available remains to be seen.