Partnership disputes are incredibly common and rank just behind death and taxes on the scale of unavoidability. Increasingly directors are discovering the versatility of debtor finance as a strategic tool to extricate themselves from untenable business relationships, and gain the upper hand on exit, as the following scenarios show.
While about 60 per cent of all debtor finance facilities are taken for working capital or to pay creditors or tax bills, about 40 per cent are events generated, and by that we mean as a tool to solve partnership disputes and divorces, or to fund mergers and product, business and brand acquisitions.
Of this 40 per cent, roughly half are used to solve partnership disputes, a testimony to just how common fallouts are between directors.
A breakdown in a partnership usually requires that one partner buy out another, posing funding problems and further arguments as to who should have an opportunity to buy the business.
Debtor finance plays a critical role in solving these problems and can also enhance one partner’s power and leverage in the buy-out process (and solve similar issues surrounding divorce settlements) as we outline in the following true cases:
Scenario One – Using debtor finance in a competitive bid process
The relationship between two partners of a labour firm company had deteriorated to a point where they detested each other. All negotiations were being conducted through solicitors. An agreement had been reached whereby the directors would engage in a competitive bid process. On a certain date, each had to lodge a bid at the other’s solicitor’s for the other’s share in the company. The highest bidder would win the opportunity to buy the company.
One of the directors approached us for advice. He had $500,000 cash and the company had $5 million in debtors. He wanted to raise $4 million from the debtors so that he could lodge a bid of $3 million, comprising $2.5 million raised from the cashflow finance facility and the $0.5 million of his own funds, while leaving $1.5 million to fund the business’s cash-flow requirements.
The day came to lodge the bids and this director lost. His partner had made a bid for $3.5 million. He thought he was going to exit the business.
But five weeks later, he returned and advised that the other partner had failed to conclude and the bid had fallen to him. Was the deal still on the table? Because the work had already been completed, it was done immediately with no requirement for property as security or need to undergo a time-consuming capital-raising process, as would have been the case had he sought a bank loan.
The interesting thing about this story is that the other partner could easily have won the bid had he too organised a debtor-finance facility. He just didn’t think of it.
Scenario Two – Removing personal property as security in a divorce
A very familiar scenario in partnership or relationship breakdowns is the need to remove a property as security for a business. Typically in a divorce, the man will take the business and the woman will take the family home but this raises problems when the property has been secured for business funding. The woman will not desire an encumbered property when she has no share in the business as it leaves the property exposed. In this instance, either partner can approach us for a debtor finance facility. Scottish Pacific advances money against the debtors, which is then used to repay the bank and establish a line of credit for working capital that is not secured by personal property. Then the division of property can be expedited, allowing for a swift, less painful divorce settlement and swift return to business as usual, reducing business disruption and giving the director the greater strategic confidence to be gained from improved cashflow.
Scenario Three – Buying out a retiring or exiting partner
Not all partnerships end in tatters, sometimes a partner will need to leave a business for any number of personal reasons. One of the most common as baby boomers age is that of the retiring partner. A client typically approaches us and says, I am 40, my partner is 60 and he wants to retire. The business is valued at $500,000. My partner agrees that he will leave the business to me rather than sell his share if I pay him $250,000. If I can’t raise the money, or we can’t find another suitable partner, we may have to sell the company. I already have a large mortgage but the company has debtors of $300,000. Upon inspection of the business and the debtors, Scottish Pacific advances the funds and its client is able to buy out his partner rather than sell the business.
Scenario Four – Removing disproportionate shares of personal risk
Another source of disagreement between partners is when one has taken on a disproportionate share of personal risk in funding the company: For example, it is their property which the bank is taking as security against funding for working capital. The partner advancing the security naturally feels they have a greater say over the way the company is run, which can be a source of conflict.
The best way to resolve this dispute is to use debtor finance to repay the bank loan and secure a line of working capital. The directors are returned to an equal footing and resentments are removed on both sides, hopefully allowing for a more amicable business relationship going forward.