Recently, a series of different reports have indicated the scale of financial distress impacting UK companies as the UK COVID-19 pandemic grinds on through its third national lockdown.
According to Begbies Traynor, in Q4 2020 there were 630,000 UK businesses experiencing significant financial distress, as we reported here. This was a massive increase on the same period in 2019, and on the third quarter of 2020.
A recent report from Begbies’ subsidiary Real Business Rescue, which we reported on here, revealed that 620,000 of these struggling businesses were SMEs. According to that report, the number of financially distressed SMEs has risen 23 per cent since the onset of the pandemic.UK
Going even further, a report from LSE and the Alliance for Full Employment (AFFE) stated that over 900,000 UK businesses (including micro businesses) are at imminent risk of closure, with a “major collapse” of businesses described as all but inevitable.
One thing consistently highlighted among these grim figures, however, is how administrations, CCJs, winding-up orders and insolvencies are near record low levels.
Given the huge amounts of distress UK businesses are experiencing, there is a very clear conclusion to be drawn from these seemingly contradictory stats: thousands, potentially hundreds of thousands, of UK businesses are being propped up by government support schemes alone, while others have avoided being liquidated due to reduced capacity of the court system.
While the UK is still in the grip of lockdown, the success, thus far, of its vaccine programme means that talk is already beginning to turn to ending lockdown and winding down government support schemes (most of which are due to end in the Spring).
With so many businesses seemingly existing in a state of suspended reality, then, the question of when the support schemes are wound down and what happens when they are is quite literally a matter of life and death for thousands of businesses.
It is, of course, inevitable that the pandemic will claim many more businesses before it finally ends. But it seems to be the case that the fate of many more is dependent upon the government getting the balance right between reopening the economy and winding down support measures.
What happens when support schemes end?
Currently, support schemes like furlough, CBILS, the Future Fund and Bounce Back Loans, are thought to be keeping thousands of otherwise unviable businesses afloat, having postponed insolvencies that may have been inevitable in other conditions.
The warning that has been sounding from some quarters recently is that withdrawing these support schemes too quickly will lead to a wave of bankruptcies that will have wide-ranging consequences, not just for business owners and employees, but the wider economy.
According to the authors of the LSE/AFFE study, the immediate withdrawal of government support measures could mean that business closures could rapidly accelerate from their current low level to, potentially, more than three times higher in Q1 2021 than in Q1 2019.
The report claims that registered businesses classed as being “at-risk” currently employ around 1.9 million people, or 8 per cent of the private sector workforce. When expanded to include all at-risk businesses, this figure rises to 2.5 million jobs – 9 per cent of the UK workforce.
Should support be abruptly switched off, a huge number of jobs are predicted to be lost en masse, resulting in massive unemployment, alongside the widespread business insolvencies.
On the brighter side, new companies are being set up at higher levels than usual, though whether this is anywhere near enough to soak up the anticipated wave of potential unemployment is unlikely.
There could also be a wider economic reason for the government to extend its support rather than bringing it to a sudden halt. If there is a wave of business insolvencies, as the LSE/AFFE study suggests, the consequences for banks could be severe, due to a huge increase in non-performing loans and loan defaults.
Jefferies economist David Owen says: “Stress testing means we can be fairly sure that banks are more robust than they used to be, but if there is a wave of corporate defaults then banks will take a large part of the hit. We need to consider how to wind down those companies without doing damage to the overall economic recovery.”
Guarding against widespread insolvencies and joblessness, then, would seem to be contingent on the extension of support measures along with the promised gradual reopening of the UK economy. Once some level of normal trade has resumed, it may be possible for schemes to be carefully wound down without triggering widespread insolvencies. But, even if this is the route taken, we shall still see an increase in administrations, insolvencies and liquidations from the many firms hanging on the edge.
The case against gradual easing
There is, however, an obvious counterpoint to the government pursuing a more gradual winding down of measures: the negative economic impact of unviable firms.
Thinktank the Resolution Foundation is among those to have criticised government schemes for creating a potential problem with so-called zombie companies, saying: “Allowing firms which are not viable in the long term to continue operating can impede the reallocation of capital and labour from less productive firms to more productive firms.”
One implication here is that the “reallocation of capital and labour” being impeded could see other firms begin to struggle as a result of unviable businesses being propped up in great numbers. We mentioned earlier the new companies beginning to emerge from the COVID-19 crisis. If a significant portion of the workforce remains in government-backed employment at unviable firms, this could severely limit the vital talent pool that young companies need to grow.
Perhaps more importantly, however, is the issue of the reallocation of capital. Returning to a point touched on in this previous insight, with funding currently focused on helping companies survive, young companies are at risk of facing a damaging funding shortfall that could stymy their growth at a vitally important stage, especially if the UK remains in a state of lockdown.
The issue of an insufficient talent pool and a lack of funding will also have a great deal of relevance for bigger companies that have weathered the crisis thus far and are now looking to how they can grow post-COVID.
Interestingly, this point chimes with one made by former Prime Minister Gordon Brown in his introduction to the LSE/AFFE report. Brown wrote: “for all its welcome focus on help through loans and the financing of the furlough, the government has said little and done little that offers struggling businesses the prospect of long-term survival.”
Another reputable institution that has warned of the potential dangers of government support schemes during the pandemic is the Bank of England. The BoE has cautioned that the aftermath of government schemes like CBILS, CLBILS, Bounce Back and the Future Fund, could mean that many financially weak – possibly unviable - firms will emerge from the pandemic with massive debt piles and no guarantee that they will be able to repay.
M&A more vital than ever
On a positive note, several factors point to an increase in M&A activity this year. These include political certainty, the end of the pandemic in sight, and robust capital markets. Mergers and acquisitions will become even more vital to the UK economy and opportunities for dealmaking will be many. Robust levels of defensive and offensive M&A activity around the globe in the second half of 2020 demonstrated that deals can get done without meeting in person, and we are seeing activity continue this year despite travel restrictions. We will see more domestic consolidation and more cross-border acquisitions.
Most obviously, distressed M&A opportunities will continue to be widespread and will increase as the government begins to wean companies off support measures.
In the aftermath of support measures, as the BoE pointed out, many firms will have racked up serious debt, all while generating minimal cashflow, and will be on the cusp of collapsing entirely. If such companies are going to continue, they will be in dire need of the financing required to restructure and eventually settle their debts, likely meaning they would be very open to a capital injection or acquisition, even if something close to normal trading has resumed.
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