Action on recapitalising business after COVID-19

20 July: Responding to far-reaching UK Recovery Corporation plans to recapitalise businesses post-COVID, ICAEW has raised a number of open questions to help inform and clarify policymakers’ decisions.

Some three million UK jobs and 780,000 SMEs are at risk if urgent and decisive action is not taken by the government to radically address a projected £35bn of unsustainable COVID-19 debt taken out by businesses during the pandemic. 

That’s the message from TheCityUK – the body representing UK-based financial and professional services businesses and organisations – in a bid to head off a financial and societal meltdown caused by the coronavirus crisis. 

The 148-page report Supporting UK economic recovery: recapitalising businesses post COVID-19 said that while the numerous government and industry schemes had helped companies survive the initial economic impact of the coronavirus, more help is needed to tackle the debt burden to “help hundreds of thousands of SMEs get back on their feet, save millions of jobs, protect billions of pounds of taxpayer money, and help power Britain’s economic recovery and future growth.” 

TheCityUK, of which the ICAEW is a member, said the options, if taken forward, present a profound opportunity for the government to leave a lasting positive legacy of regional growth and investment across all parts of the country. 

Birth of the UK Recovery Corporation 

Key among the proposals is the creation of a new government-backed ‘UK Recovery Corporation’ that would issue, hold, oversee and manage ‘unsustainable’ debt, to both support funding on more manageable terms for businesses, and provide a vehicle in which the private sector could invest in over time. 

Via the UK Recovery Corporation, suitable SMEs would be offered the opportunity to convert their loans into new products empowering them to manage their debt more sustainably without being put into default.

Depending on the size of their liability, they could either access a ‘Business Repayment Plan (BRP)’ to convert unmanageable loans into means-tested tax liabilities, or for larger debts, use ‘Business Recovery Capital (BRC)’ to convert crisis loans into preference shares or long-term subordinated debt. Both options aim to ensure SMEs do not sacrifice equity in their business. 

Another proposed option in the proposed armoury of measures is the creation of a new growth capital fund, Growth Shares for Business (GSB), which will allow SMEs to rebuild cash reserves, invest in working capital and relaunch after the crisis. 

Liquidity and recapitalisation

Given businesses need to start repaying their COVID-19 loans in March 2021, and the government’s stated aim to end its furlough scheme in October, it’s clear, says TheCityUK, that such firms desperately need not just liquidity, but also adequate recapitalisation. 

The options put forward by TheCityUK Recapitalisation Group are the result of the combined effort of over 200 financial experts from across 50 financial and related professional services firms, overseen by EY. It was brought together through consultation with HM Treasury, the Bank of England, and the Financial Conduct Authority, as well as business associations including ICAEW. 

Omar Ali, UK financial services managing partner at EY and Chair of TheCityUK Recapitalisation Technical Working Group, said: “Over the next few months, as the government furlough scheme starts to taper off, deferred rent and VAT payments become due, and operating losses continue to accumulate, hundreds of thousands of businesses across the UK will face difficulties repaying the debt they have built up during the pandemic. 

“The options we present are the collective work of our industry, which has come together and worked at speed to find solutions to this imminent debt challenge that will ultimately impact us all. Our analysis suggests that some sectors may enter into difficulty as early as autumn this year. That is why taking action now is vital if we are to help businesses get back onto a stable footing as we emerge from the pandemic and will ultimately support the UK’s economic recovery and fuel its future return to growth.” 

From public to private funding

At its launch, the report suggests the UK government should be the principal investor in the UK Recovery Corporation. Over time, and depending on the policy decisions implemented, private investors could step in to provide finance to the UK Recovery Corporation through securitisation or by acquiring portfolios of instruments, potentially providing a long-term legacy of SME investment across parts of the UK traditionally untouched by equity investment. 

TheCityUK Recapitalisation Group has proposed two key options which would be managed and held by the UK Recovery Corporation: the BRP and BRC. 

The Business Repayment Plan (BRP): This is targeted at small businesses with a Bounce Back Loan Scheme (BBLS) or small Coronavirus Business Interruption Loan Scheme (CBILS) loan under £250,000.

These businesses would convert the outstanding loan balance into a tax obligation administered by the UK Recovery Corporation but repaid through the tax system. This would be means-tested, ensuring businesses only pay what they can afford, which could be calculated based on taxable profits or another measure of business recovery. There may also be certain restrictions on the borrower (such as the ability to pay dividends or dispose of assets) to ensure that tax obligations are repaid as a priority. 

Business Recovery Capital (BRC): The BRC is aimed at larger businesses with a CBILS loan up to £1m. Businesses would be able to convert their government-guaranteed loan into subordinated debt (an unsecured loan that ranks below others) or preferred share capital (that provide fixed dividends ahead of ordinary shareholders). These are non-voting instruments and, while there may be certain restrictions on borrowers that utilise the instrument, the report says that they should not lead to a business owner or founder losing control of their business. 

A third option is Business Capital Growth Shares (BCGS). These could be created and held by a new or adapted growth capital fund. This would be for viable SMEs that have either not taken out debt or can repay their debt but still need growth capital. This would allow them to rebuild cash reserves, invest in working capital and relaunch after the crisis. The growth capital could help support the regeneration of local and regional economies to drive the long-term recovery of communities across the UK. 

Critical thinking 

However, several key questions remain about various aspects of the schemes. In a letter to Sir Adrian Montague, chairman of TheCityUK’s leadership council, Vernon Soare, the ICAEW’s Chief Operating Officer, outlined several points in response to the Recapitalisation Group’s initial thinking. Soare offered up a number of open questions to help inform and clarify points made in the report. 

Concerning the Covid Business Repayment Plan and the Covid Business Recovery Capital schemes, Soare stressed that they could be “complex products that will be difficult for unlisted SMEs to understand and administer” and that by “seeking broad ‘rules-based’ eligibility and permitting accelerated entry before default, careful control and accountability will be needed to ensure optimum outcomes for customers”. 

It is welcome to see in the final report that a more conventional subordinated debt option is considered alongside preference shares and that borrower consent will be required before scheme entry.

But more detailed development and review will be necessary before the proposals can be adopted. In his letter Soare pointed out that they would both need “extended government support as well as careful costing, including administration costs, to enable their evaluation alongside other options”.

Driving better economic value for the taxpayer 

The likely costs to the government of the existing loan schemes should be carefully reviewed, continued Soare, while the cost of direct support to banks to enable significant extension of term loans, or other similar forbearance mechanisms, may in some cases deliver better economic value to the taxpayer. 

Referencing the UK recovery corporation (UKRC) plans, Soare asked how its assets could best be constructed to enable their onward sale, given that “this was a valuable exit route for the government from its investment in the Northern Rock and Bradford & Bingley mortgage books”. Furthermore, as underperforming SME loans will be a significantly higher risk asset class, they could prove extremely challenging to securitise without additional, and costly government support. 

Financial reporting requirements 

Soare also asked what financial reporting and audit requirements will be expected from businesses at their point of entry and during holding by the UKRC, especially as many companies within the proposal’s scope will not currently prepare audited accounts. This is a crucial element, he stressed, so that other creditors can be furnished with “transparent information about entities going into such schemes and the UKRC will itself need reliable data”.

Similarly, the government and public need reliable aggregate information about the position and performance of businesses in the plan. 

Public consultation is vital 

The report raises many questions that will need detailed consideration. They include the expected cost and economic impact of further mutualisation of private sector debt, via the tax system. Issues also arise from the expected approach of HMRC in pursuing CBRP and other tax debts, especially given the reintroduction of ‘Crown preference’, due to take effect in December. 

He also highlighted other key areas ripe for further exploration such as the process for handling small business failures, the route for scheme entry and how to best ensure the fair treatment of customers.