Rising debts and reduced cash flow create SME acquisition opportunities

To the casual observer, it may seem that the worst of the well-documented problems afflicting UK businesses over recent years have passed. The vaccination programme has helped bring about an end to damaging lockdowns and the tumult of the drawn-out Brexit process is finally over.

However, the reality for many businesses in the UK, particularly small and medium-sized firms (SMEs) is that the worst effects of these twin crises are only just beginning to be felt. As we head into yet another uncertain autumn and winter, many SMEs are suffering from mounting debts and severely reduced cashflow – issues both directly related to COVID-19 and Brexit.

These problems are creating a situation in which totally viable SMEs, some with extremely high potential, are teetering on the brink of (or already deeply mired in) financial distress. Adding to the pressure on small business owners is the fact that this is occurring alongside the gradual withdrawal of COVID-related safety nets.

Aside from Brexit and the pandemic, however, the current struggles of SMEs are also exacerbating long-standing issues that have been plaguing the market in recent years. For parties with the capital and appetite to do deals, this scenario looks certain to create a raft of exciting acquisition opportunities (both distressed and otherwise) over the coming months.

What are the issues facing SMEs

Debt
Almost certainly the key issue facing many SMEs (albeit one that is being compounded by numerous other factors) is the high levels of debt many have accrued during the pandemic and now face the burden of repaying.

According to a recent survey of 511 SME decision-makers undertaken by YouGov and commissioned by business legal advisory LawBite, 59 per cent of SMEs in the UK either took on a government loan during the pandemic or placed employees on the government’s furlough scheme.

Many SMEs will have taken on loans from either the Coronavirus Business Interruption Loan Scheme (CBILS) or Bounce Back loan scheme. CBILS offered loans of up to £5 million to SMEs, while the Bounce Back scheme provided small businesses with loans of between £2,000 and £50,000.

CBILS loans were 80 per cent government-backed, while the government assumed 100 per cent of the risk on Bounce Back loans. Under both schemes, no repayments would be requested for the first year and the government would cover any interest and fees for the first 12 months.

When these schemes were launched in March and April of 2020, these probably looked like highly attractive terms to business owners, many of whom perhaps felt the COVID-19 crisis would only last a few months before normal trading conditions resumed.

However, with payments now falling due on these loans, following well over a year of heavily interrupted and restricted trading, many businesses are finding it difficult to make repayments. Meanwhile, with the furlough scheme winding down, many of the same businesses will face the additional burden of having to pay more in wages.

Ten per cent of businesses surveyed by YouGov/Lawbite that had taken on government loans now say that cash flow and supply chain issues mean they will be unable to repay them. Applied to the wider UK SME sector, this suggests that close to 350,000 could be unable to repay COVID-related debts.

Meanwhile, in a separate survey by AXA UK and the Centre for Economics and Business Research (CEBR), 24 per cent of SME owners cited their biggest worry as being repaying the debts they racked up during the pandemic.

Adding to this pressure, the government has recently announced that temporary insolvency measures will be coming to an end. For businesses that have racked up creditor debts during the pandemic, this puts them at a high risk of insolvency action.

Many business owners will have doubtless been glad to hear that the government isn’t yet ending restrictions on winding-up petitions relating to commercial rent. However, these protections are only set to last until March 31 2022, putting further pressure on those with rent arrears to repay them before that deadline.


In September, Samuel Daw & Company, a Dorset-based tailor and schoolwear specialist dating back to 1874, fell into administration as a result of debt accumulated during the COVID-19 pandemic and cash flow issues.


The business, which traded from a single location in Barnstaple, was a successful local retail business working with schools in the community and known for the high standards of its menswear and schoolwear.


Portland Business Recovery was appointed administrator to the business and began actively seeking a buyer, alongside commercial property consultant Lambert Smith Hampton.


Discussing the business’ struggles and the wider difficulties facing SMEs in the UK, Portland Business Recovery director Steve Godwin said: "We yet again see another successful retail business go into administration due to the knock-on effects of COVID-19 restrictions.”


"Despite Daw & Co's diverse market and customers base, which included local businesses workwear, schools and educational establishments as well as the general public, the sudden drop in sales has meant that it is no longer financially viable for it to continue to trade.”


"It is unfortunate to see another much-loved business, such as Samuel Daw & Co, fall victim to the worldwide pandemic. Once furlough and government support ends in September, and as businesses are required to budget for the repayment of deferred debt and Bounce Back and CBILS Loans, we could see many more of them struggle to meet their financial commitments. This could lead to Insolvency and ultimately mean that many well-known brands may disappear forever."



In June, Colchester-based sister firms Alexanders Discount and Corporate Commercial Collections (CCC) fell into administration amid financial difficulties. The companies, which provided funding for UK businesses in sectors ranging from construction to recruitment, owed a significant amount to creditors, having taken on separate loans of £7 million and £5 million in the year prior to administration.


Upon appointment, administrators from FRP Advisory said that the companies “did not have sufficient working capital resources to properly fund the purpose of the business”.


Two months later, in late August, the firms were acquired from administrators by Oldham-based invoice finance firm WeDo Invoice Finance in a multi-million pound deal. The deal saw the businesses absorbed into WeDo’s operations, increasing the company’s presence in the south.


Commenting on the double takeover, WeDo co-founder Chris Robinson said: “We are an ambitious and expanding company and, as part of our growth strategy, we have been seeking to increase our presence in the south.”


“The businesses we have acquired have good management teams and lots of synergies with our existing operations, so we are thrilled to have been able to take advantage of the opportunity to buy them.”


Robinson added: “It was important to get the transaction done quickly to alleviate any uncertainty among the client base of the businesses as a result of them being placed in administration. Thankfully, we have been able to reassure them that we are there for them to support their growth objectives.”

Supply chains
Disruptions to supply chains within the UK have been one of the most prominent news stories of the past few months – driven by issues related to both COVID-19 and, in particular, Brexit – and the effect has perhaps so far been most acutely felt by SMEs.

The South West Manufacturing Advisory Service’s (SWMAS) recent Manufacturing Barometer provided a valuable insight into how supply chain issues are impacting SMEs in the UK’s manufacturing sector.

According to the report, 96 per cent of UK SME manufacturers are struggling due to price changes in their supply chains. Delving into the reasons behind this, 94 per cent attribute these changes to a lack of available raw materials, 82 per cent to rising transport costs, while 63 per cent cite a reduced capacity to meet demand as resulting in higher prices.

Many of these issues are directly related to Brexit, which has restricted freedom of movement between the EU and UK, contributing to shortages of HGV drivers, while increased border checks means that imports and exports now take considerably longer.

For many SMEs (not just those in the manufacturing sector), this will mean that prices within their supply chain increase. This not only damages cash flow, it puts businesses at risk of both incurring debts or finding themselves owed larger sums by firms they supply to.

As highlighted in the YouGov/LawBite study, this is materially impacting the debt problems SME owners are facing, with 10 per cent of those who took on COVID-loans currently unable to repay them due to supply chain and cash flow issues. In addition, close to 25 per cent of owners say that late payments as a result of the need to make loan repayments are impacting their supply chain.

Sadly, late payments within a supply chain often have a domino effect. Coinciding with the withdrawal of financial support and insolvency protections, supply chain issues are another factor putting SMEs at serious risk of creditor action.


In August 2021, one of the UK’s top piling contractors All Foundations fell into administration as a result of financial difficulties encountered by the firm during the COVID-19 pandemic.


At the time of its most recent accounts for the year ending March 31 2021, the company reported turnover of £13.2 million, but owed creditors close to £5 million.


The impact of the pandemic ultimately pushed the firm into insolvency, with a spokesperson for administrators FRP saying: “The business experienced significant disruption to its revenue and cashflow since the start of the COVID-19 pandemic, due to the impact on the wider construction industry, which led to the insolvency.”


The company was acquired in a pre-pack deal by Founda Ltd after joint administrators Yasmin Bhika and John Lowe of FRP ran an accelerated merger and acquisition process.


The administrators stated: “Upon appointment of the joint administrators, the business and assets were sold through an accelerated merger and acquisition process. The transaction has secured the future of the business and enabled the TUPE transfer of all 35 employees. The business continues to trade and operate.”

A lack of investment threatens recovery and progress
Some of the SMEs affected by restricted cash flow and mounting debts will emerge intact from the COVID-19 pandemic by gradually trading their way back to health as restrictions ease and the economy reopens.

However, this will not be possible for many of the worst-affected small businesses, opening the door for distressed acquisitions. Revenue generated by normal trading may also not be enough for business owners who are looking to generate rapid growth. In order to do that, owners may need to make significant financial investments. This though is another area where SMEs are running into difficulty.

Reduced cash flow and the need to furnish debts will obviously restrict the ability of business owners to invest, but this is merely exacerbating a long-standing problem. As we covered in a recent insight, a lack of long-term funding options are severely limiting the growth prospects of many of the UK’s highest-potential SMEs.

While debts and cash flow problems perhaps pose a more immediate threat to SMEs, it is possible that a lack of funding could be just as damaging to the sector’s long-term recovery. The AXA/CEBR study showed that one-fifth of respondents said that they thought new technologies would bring greater efficiencies to businesses in the near future.

This is great news for SMEs, providing they can afford to invest in such technologies. A lack of funding amid the other pressures impacting businesses could threaten this, raising the question of how many SMEs will be able to make the kind of investments they need to take their business forward.

Indeed, the YouGov/LawBite study found that 40 per cent of small businesses that were suffering from COVID-related debts said that their financial situation meant they were unable to invest in new technologies or products.

Avoiding imminent closure will of course be the priority for a majority of SMEs, but the ongoing crisis in long-term funding means that many businesses (even if they can repay their debts) may not be able to truly recover from the pandemic and realise their potential without outside investment.

Future uncertainty
Finally, a crucial fact to bear in mind throughout this discussion, is the fact that the COVID-19 pandemic is still very much with us and is still having a huge impact on small businesses.

The vaccine programme has no doubt been successful, saving many lives and enabling an element of normality to return. However, the uptake of jabs is beginning to flag as the vaccine drive tries to reach those most reluctant and, with most restrictions now lifted, the UK is entering autumn with daily cases far higher than they were a year ago – prior to last winter’s deadly second wave.

These factors, along with other potential threats such as new, vaccine-evading variants and a bad winter flu season, mean that the possibility of another ‘firebreak’ lockdown cannot be entirely discounted. For thousands of businesses, such a scenario could prove fatal.

According to the YouGov/LawBite study, 18 per cent of business owners polled said that they remained worried about the implementation of further restrictions in future.

Another concern for businesses given the uncertain, ongoing nature of the pandemic is that consumer habits may change as we enter the winter and perhaps in the longer-term. With more people shopping online than ever, customers may be less likely to turn to independent businesses. As a result, 18 per cent say that they are worried about long-term changes to customer behaviour.

Conclusion – Distress and frustration spell opportunity

The brutal truth is that mounting debt and declining cash flow will naturally push many SMEs, which have already suffered so much during lockdowns, to a point of severe financial distress. Administrations and insolvencies have already begun to rise in recent months and this can be expected to exponentially increase with the withdrawal of insolvency protections.

For opportunistic buyers, this means a plethora of opportunities to acquire distressed companies that have been forced into insolvency, as well as the scope to take over businesses desperately seeking a sale prior to entering administration.

Due to the severe nature of the crisis engulfing SMEs, many of these will not be the usual calibre of failing business, but will be genuinely high potential firms that have perhaps just succumbed to a range of different pressures and are available at low valuations.

However, the problems facing the SME sector go far deeper than that, and opportunities may not just be limited to those looking to snap up distressed businesses. Numerous high-potential SMEs will be hoping to use the end of COVID restrictions as a springboard to grow, but find that they lack the working capital to do this.

Measures such as staff redundancies may help them to free up the capital to make loan repayments and normal trading conditions may improve their cash flow. But this alone may not be a satisfying solution for high-potential SMEs looking to build for the future, rather than simply survive.

A frustration at a lack of long-term funding options, combined with COVID-19 debts and uncertain cashflow, could lead many SMEs to consider seeking a buyer with the capital to invest in the business. This could of course prove extremely advantageous for buyers looking to take on innovative SMEs and drive them to significant growth.

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