Plotting A Path Through Choppy Waters

It is clear that the disruption caused by Covid-19 is far from over, but as the economy is unlocked, what does the future look like for business? Ben Madden, Head of Corporate and Commercial takes a look at how the Government’s support measures have attempted to cushion the blow for UK businesses and predicts what’s in store in the months ahead.

Economies around the world continue to suffer from the effects of the Covid-19 pandemic. Governments have imposed restrictions on their populations, which have hampered activity in numerous sectors of their economies. As health services have tackled the outbreak and more is known about the virus and how it spreads, those lockdowns and restrictions have been relaxed where possible, but the outlook remains uncertain and the path forward has some way to go.

Taking advantage of the support measures

Here in the UK, the Treasury has implemented various support measures and sought to manage the negative effects felt by businesses and individuals, whether by creating a government subsidised loan scheme through High Street banks, by making grants available to businesses, or by underwriting continuing employment costs by allowing businesses to furlough staff through the job retention scheme. 

In addition, following a lengthy consultation process, and an implementation phase that had to urgently accommodate measures targeted at the effects of the pandemic, the Corporate Insolvency and Governance Act 2020 took effect on 25 June 2020. The insolvency framework has been updated, making it possible for companies to take advantage of breathing space in the form of a moratorium with insolvency practitioner supervision, or enter into a creditor sanctioned restructuring plan. These measures add to the existing toolbox of insolvency procedures such as liquidation, administration and company voluntary arrangements. Companies and insolvency professionals will no doubt welcome the developments in principle, but it remains to be seen how effective these new procedures will be in practice, and how many companies take advantage of them.

Survival of the fittest

Further legislative measures have given additional breathing space to companies, for example payment demands could not be enforced as readily by creditors, and tax payments could also be delayed. While companies under distress could not trade as freely as they would like in the second quarter of 2020, they were not immediately under the same pressure as they might otherwise be.

The side effect of this cocktail of measures and legislation will inevitably have meant that many businesses have incurred further debt to stay afloat. Once the cushion of enforced measures ceases to take effect, and if those measures are not supplemented with new targeted measures, the outcome over the past few months has been inconvenient for many at best, and a number of these businesses will struggle to survive the hangover that surely comes in the wake of the virus.

The concept of the zombie company has grown over the past decade or so – those companies that survive day to day but do not grow, surviving really only by taking advantage of forebearance of creditors, low interest rates and other measures and benefits available. Insolvency data from the past few months indicates a spike of corporate insolvencies in March, before the lockdown and support measures were announced, but in the months since then, though there have been some high profile casualties, the rate of insolvencies slowed substantially, to substantially below 2019 levels. This reduction can only be temporary however, and we should anticipate a wave of insolvencies in the coming months as businesses become overburdened by debt.

Readjusting business models

Not only for zombie companies but also for many others, the Covid-19 pandemic, its economic side effects and changes in behavior will have put inevitable strain on working capital, and Government support measures will have a finite lifespan. Some businesses will not have been able to re-open as the economy has otherwise been unlocked, as owners count the cost and readjust their business models.

Some sectors have flourished in the current situation, adjusting to online sales and altering their methods of delivery and trade. Some may have taken a gamble on longer lasting changes to the way business is conducted, and of those, some gambles will not have paid off fully as traditional methods of trading return and evolve.

Opportunities for buyers and those looking for an exit

So, what does this mean for businesses out there? Where there is the possibility of distress and insolvency, this brings the prospect of job losses and rising unemployment, a hardened jobs market, and a loss of skills within some of the businesses that survive as they adjust to a new reality. Established businesses and start ups might not be able to obtain funding as easily as they would like, potentially triggering failure. On the flip side, their competitors may be able to grow their business in an emptier marketplace, with opportunities arising to acquire the assets of failing or failed businesses.

There will be gaps that enable new businesses to spring up, as has been seen in previous times of crisis. Though each of them has had its teething problems in the past few years, the likes of AirBnB, Groupon, Uber and WhatsApp were only set up in late 2008 and early 2009 and disrupted established businesses in their sectors. Previous economic crises have witnessed businesses such as Hewlett Packard, IBM and Disney develop and thrive in the decades since.

There are lessons to take on board for acquirers and those selling their businesses. Those who are selling, as ever, will benefit from having all relevant information close to hand for due diligence. They should do what they can to ensure that issues they’ve faced in the past have been addressed and properly resolved. Thereby they can minimise the opportunities for acquirers to impose reduced valuations or to structure transactions so that they are linked to future performance and both sellers and buyers share an element of risk.

A greater focus on forecasting

Suppliers and customers may also try to negotiate harsher payment terms in the case of continuing business relationships, and sellers will need to anticipate more cautious and detailed due diligence, whether by acquirers themselves or required by their backing funders. There will inevitably be a greater focus on forecasting, and valuations based on figures available at the time of acquisition, i.e. using completion accounts rather than historical data that reflects a past that was not affected by Covid-19.

Transaction structures might in some cases be simplified to reflect an urgency to proceed, but in many instances those structures may be more complex, to accommodate funding considerations or to reflect genuine caution on the part of buyers and investors.

So, where does this leave us?

It is clear that the disruption and chaos caused by Covid-19 this year is far from over, but as the economy is unlocked, confidence is returning, necessity takes over, and patterns will emerge. In our own commercial practice at Clarkson Wright & Jakes, we have seen an increase in transactional activity over recent weeks, in that some transactions that were put on hold are once again underway, and a pipeline of new and returning transactions is starting to develop. This is all currently fairly tentative, and any future restrictions and lockdown would affect activity now ongoing.

Government support measures will fall away over time, meaning that some businesses will fail. This brings opportunities for those who sift through the wreckage of those failures, as buyers conduct any due diligence they are able to within the timescales available and seek to arrange funding. For those looking for investment or to exit, their focus should be on achieving a smooth process of providing information and carefully managing their future involvement. For those of us advising on either side, we’ve got to keep up to date with trends and developments, apply the skills we’ve developed, and use what we’ve learned through this state of affairs and in the past, to help our clients plot a path through the choppy waters. It has been and will continue to be a bumpy ride.