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Government support and the day of reckoning for small businesses

Author: ICAEW Insights

Published: 26 Apr 2021

Small businesses that have accepted government support in the form of CBILS and Bounce Back Loans may find themselves at a crossroads as they seek a way through distress into recovery. We speak to Rebecca Dacre, Partner at Mazars, and a licensed insolvency practitioner.

“I work with privately owned businesses – lots of them are family businesses,” says Dacre. “Some are doing really well. They have taken government support, and, in many cases, it's given them not just a lifeline to survive through the coronavirus process, but also the opportunity to turn themselves around, and to come back even stronger.”

She cites examples of companies that would have failed before the pandemic, but the opportunity to furlough staff has given them the breathing space in which to restructure then recover so that productivity could increase. “One client actually broke even last year for the first time in many, many years,” she says. “It survived because of the support from the government.”

Dacre is also receiving enquiries from companies that have investors lined up and ready to provide investment to support the company through recovery. But many of the companies and investors are unsure about the status of that investment in the light of CBILS and bounce-back loans taken from the government, and HMRC arrears accrued during the pandemic.

Now companies are asking if a mechanism is available whereby they can be relieved of the burden of debt. “Most of these companies have been paying their suppliers, so the trade position is fairly clean,” says Dacre. “But some are looking at whether they should they carry on with the company as it is, or if they could, instead, use an insolvency process to wipe it clean and potentially start afresh.”

Acting in the best interests of creditors is the priority when a company approaches insolvency proceedings, and these companies are cashflow solvent – not close to insolvency – albeit that they have significant liabilities, way in excess of their assets, incurred under extraordinary circumstances. Closing a business at this time might not be the right thing to do from the creditors’ points of view as the company may be able to trade out of its position, and mothballing a business could reduce the value significantly, potentially resulting in poor acquisition outcomes and poor outcomes for creditors, points out Dacre.

Conversations around these issues can be tough for an insolvency practitioner. Of course, it will be attractive to directors to wipe the slate clean – and potentially acquire the unburdened business or allow an investor to do so – but, ethically, is this the right thing to do? Or should directors pursue the business, endeavour to return it to profit, and pay back the debt?

“I have seen that directors feel responsible for the support they have accepted, they are very grateful that the government has been supportive,” says Dacre. She points out, in many of these circumstances, the directors can legitimately instigate an insolvency process but is it the right thing to do for the creditors? Are their problems actually surmountable to the extent that they may not necessarily need the insolvency process, even though they have access to it? Would it be better for both the company and the creditors in the long run, if negotiated settlements or debt reductions could be achieved outside of a formal insolvency process?

Dacre points out that under usual pre-pandemic circumstances there is a natural reticence for directors to use the insolvency process, partly because of the impact on suppliers, but also because of the loss of reputation. If suppliers have been paid and the only creditor is HMRC or the bank (and the bank hasn’t taken personal guarantees), that shifts mindsets in some cases. This could result in less of an emotional barrier to using the insolvency process and lead to higher insolvency rates, but there is still a moral and ethical conversation to be had in addition to the typical conversations about directors’ duties. This can put insolvency practitioners in the position of turning away work, after all, they are advising the directors on what steps they should take to look after creditors’ interests and, in a reflection of the current unusual position that businesses are in, the right thing to do may be to continue to trade and repay the debt.

Perhaps part of the problem is that owner-managed micro-businesses are generally not used to debt. Quite often, those who set up businesses are accidental entrepreneurs who make a lifestyle decision to set up a business with no real concept of what that could mean over time and in extreme circumstances. Perhaps they never had on their radar huge levels of debt and only ever thought they would be reinvesting profits with the downside of lean years early on. Then comes growth and that accidental entrepreneur becomes a businessperson, with a payroll and supply chain, and now government debt. Now they have to think like proper senior management, not kitchen table entrepreneurs.

“We’re also seeing the need for proper forecasting. A lot of the businesses that we deal with have a small accounts team, or just one person doing their accounts. They may not have the depth of experience to prepare a forecast to say, when these loan payments kick in, what's that going to look like for the next six months, 12 months, or five years?” says Dacre. “Besides, it’s really difficult to produce an accurate forecast because no one can predict what will happen over the next few months.”

And it is fair to say there are instances where companies have taken out multiple CBILS loans and are now more leveraged than they have ever been. The monthly repayments may be overwhelming.

Dacre says she is seeing the most stressed directors she has ever seen. “They are under huge amounts of pressure. And that is going to have its own repercussions in terms of how they run their businesses going forward. It's really difficult to make good decisions when you're under that much stress. And it also has huge impacts, of course, on their families,” she says. “Smaller businesses never expected to be in the financial situation that they're now in. And they almost certainly wouldn't have been in that position without COVID.”

The concern is that at this time, directors may act out of character, and they might be vulnerable. What might conversations with them look like?

“It’s very difficult to be black and white in insolvency practice. There is always a grey area, but we do always take a very ethical position. I have said to some directors that I could not recommend that they go through an insolvency process because, although it was available to them, it was not in the best interests of the company's creditors at that stage. We have to maintain our position and give the right advice.”

Dacre warns that directors put themselves under stress because they feel they need to have all the answers. Sadly, they are on the road to nowhere.

Insights Special: Business Rescue

Conversations are intrinsic to business rescue. Be they with a chartered accountant, a bank, HMRC or any other trusteed individual, business restructuring, refinancing and recovery depend upon communication.

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