Whether publicly listed or privately held, companies across the home interiors industry are struggling in the current climate. The Pier, Land of Leather, Sofa Workshop, MFI, Rosebys and ScS Upholstery have all fallen into administration in the past 12 months, unable to survive the poor property market and the retail slump.

However, one man's business failure can bring another possibly irresistible opportunity. The most pertinent example, of course, being when Smallbone, the previously AIM-listed luxury kitchen manufacturer, was put into administration earlier this year and serial entrepreneur Leo Caplan bought the company almost immediately through a pre-pack deal.

So could you do the same?

Of course, buying out of administration is not for the faint-hearted. There are a number of complex issues that must be addressed, certain businesses will not be viable and any potential buyer will need to look carefully at what needs to be done differently for the company to succeed where it has previously failed.

Moreover, a purchaser will have to buy the company without any warranties from the vendor - effectively 'sold as seen'.

But for a well-capitalised, forward-looking company or entrepreneur, buying a business out of administration can provide a great strategic opportunity and the ability to gain customers, facilities, brands and a workforce at what could potentially be a very good price.

Where to start

The first step for those considering such an acquisition is to carefully assess the associated risks and rewards. Proper planning needs to be implemented to ensure that the business - or worse, the acquiring group - does not end up in the same position six months down the line. It may be possible, and more worthwhile, to gain the customers naturally without acquiring the failed business.

In considering whether the business can be viable, it is crucial to determine why it failed and whether appropriate changes can be made to allow for a successful turnaround.

For example, if the underlying business is fundamentally sound and profitable, but its debt burden became unserviceable - for example, the company had too much debt following expansion or acquisition - then creating an appropriate funding structure may be the key action required. Pension liabilities or onerous property lease obligations can sometimes be renegotiated or left behind, and customer loss or bad debt can be factored into the negotiations and hence the price paid for the business - this is why you often see companies bought for £1.

Although certain creditors may not be assumed by the purchaser, the impact of such actions must be assessed very closely. For key trading suppliers essential to the 'new' company, the acquirer may have to factor in some kind of payment against the arrears, potentially through a price uplift, depending on the relative leverage of both parties.

Management deficiencies can also be a major factor in company failure, with the current downturn causing real problems for inexperienced directors, who may, for example, find it difficult to focus on cashflow rather than turnover. A purchaser with the skills and knowledge to run the business more effectively may be able to turn the company around, although as with all businesses in the current climate, close management of cash will be vital.

More challenging issues can arise if there has been a severe downturn in a particular sector, or in a mature sector that provides minimal opportunity for future growth. In such cases, the solutions are often limited to consolidation. However, if synergies can be driven from a purchaser's existing business through revenue growth opportunities or cost-saving measures, such as more efficient purchasing or integration of existing cost centres, these may be able to drive profit improvement and provide a strong rationale for the acquisition.

Due diligence

If the initial analysis is positive, and an indicative offer acceptable, the transaction will move to the due diligence phase. The potential buyer's knowledge of the business and sector, as well as the process being run, will dictate the level of diligence performed. For a start, this type of acquisition is usually a business and asset purchase rather than one of shares. In addition, there is often much shorter time available to do the work, given that value can rapidly disappear while a company trades in administration.

In terms of due diligence, the key focus should be on the following areas:

The management of the business: This needs to include the right people with the right skills and experience to turn the business around.

Review of contracts:  if key customers are able and likely to stop trading with the business, the target's value may diminish very quickly.

TUPE liabilities: it is likely that a failed business will not have an appropriate cost base, so staff may need to be cut and careful planning and legal advice will be vital.

The valuation of assets and any liabilities: recoverability of such assets will be critical, and valuation important in finance raising.

Assessment of the risk of retention of title claims by suppliers: varying Stock Payment Agreements (SPA) clauses can be agreed, allowing the purchaser to maintain relationships with the supplier and settle any claims. Guarantee from the vendor.

Pre-pack

Another route when buying out of administration is a pre-packaged deal or a 'pre-pack', where a buyer is approached and a deal secured prior to declaring insolvency. This is how Leo Caplan bought Smallbone and Moores Furniture acquired the Four Seasons brand and stock from BGH.

A 'pre-pack' may occur for a number of reasons, including if it is perceived that a business would be unable to trade in insolvency and hence value for creditors would disappear very quickly once the business enters administration. This can be due to such issues as terminated customer contracts or the loss of key employees. In both cases, a speedy resolution to ownership is desirable. A pre-pack may follow a period of marketing prior to insolvency, allowing administrators to fast track the aquisistion process and avoid such loss in value.

In a pre-pack, the administrator must demonstrate that the best value for the creditor group has been obtained. Any challenge against this is particularly great when making a sale back to the original management team and some banks will not fund such a transaction.

In any disposal of a business in insolvency, the administrator will need to run a competitive process, and will not always offer exclusivity in order to help maintain tension and avoid price chipping. They will want to see proof of funding early on with a preference for cash consideration.

The acquisition (via a pre-pack) by US private investment firm Sun European Partners of the HomeForm Group - the company behind Moben, Sharps and Dolphin - is a good example of how strategic decisions had to be taken by the purchaser to protect the assets they were buying.

The business operated from facilities in Manchester and Wolverhampton and, at the time of acquisition, had more than 160 showrooms. Sun took the strategic decision that all HomeForm Group customer commitments, deposits and delivery dates for goods that had been ordered but not yet fitted would be honoured, along with all warranty and product guarantees, despite having no legal requirement to do so.

Because of the sheer complexity of the deal and the risks involved, an acquisition out of administration is not for everyone. Many administrations will be a real case of 'buyer beware', requiring significant amounts of research, the confidence and experience to make some difficult decisions, and the skills to transform the business.

However, under the right circumstances, it is possible to pick up a business at a fraction of the pre-administration value, and often at a significant discount to the net asset value. More importantly, it can be a valuable opportunity to gain market share and strengthen an existing business.

Matt Widdall is a director in corporate finance advisory and Clare Boardman a director in reorganisation services at Deloitte

What is administration?

Administration is a legal procedure that allows a business in financial trouble to keep operating without being forced to sell off assets to pay debts.

The idea is to give the company a breathing space in which it can restructure its finances and hopefully put its business in better shape.

Those owed money by the company will usually prefer a period of administration over a move directly to liquidation because they've got a better chance of getting their money back.

Administration also makes the company more attractive to potential buyers as the legal purpose is the survival of the business as a going concern.

Administration begins with a petition to the magistrates court by the creditors or, more usually, the directors. The court then appoints an administrator, usually a specific named person at an accountancy firm.

Their job is to run the business with the aim of getting as much money as possible for the creditors and make a series of proposals regarding the company's future - such as the sale of assets.

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