Follow early signals to avoid a train wreck

A dramatic spike in company insolvencies in England and Wales is the start, not the peak, of more mid-market business fatalities, with many “sleepwalking into a train crash” under growing financial pressure.

That’s the grim prediction from Nicola Clark, insolvency partner at Azets in the North West, who is urging business owners to be proactive in their approach to the challenges they face, with the true impact of the global economic crisis yet to be felt.

She stresses that businesses have significantly more options available if they are alert to danger and consult early.

The latest figures released by The Insolvency Service show the annual rate of company insolvencies in England and Wales is now the highest it has been in eight years.

In the 12 months to August, a total of 20,512 insolvencies were registered. This is 16 per cent more than any 12-month period since 2019 and 26 per cent higher than any calendar year between 2014-2018.

Added to that, analysis by R3, the trade association for UK insolvency and restructuring professionals, shows the upward trend in the 12 monthly rolling numbers, which started in April 2021, has continued to rise at the same steady pace, and is now 72 per cent higher than a year ago.

Assessing the situation, Nicola says: “The current economic environment, characterised by rising prices and tighter financial conditions, is impacting companies’ ability to service debt.

“Economists believe it is a case of ‘when’ not ‘if’ the UK eventually falls into recession. And it is highly likely that the cost of business will increase, especially for companies that have taken out non-fixed rate loans.

“Many businesses relied on loans to cope throughout the pandemic, and consecutive interest rate hikes have come at a critical time for many who are already struggling to stay afloat.

“This is the start, not the peak, of more business fatalities. The next 18 months will be extremely challenging, and many businesses are sleepwalking into a train crash.

“But there are several options available that will reduce risks and ensure a business is ready to take advantage of an upturn – if advice is sought early enough.”

Nicola spells out some of the options available to struggling businesses. She says: “Securing funding from a lender that invests in distressed businesses in exchange for equity would enable the preservation of the business and retention by management of some equity, while avoiding the crystallisation of any personal guarantees they may have entered into.

“At first blush, this might seem unpalatable to an owner-managed business – but the reality is that a smaller percentage of something is better than 100 per cent of nothing.

“Where management would prefer to retain control of the business, they could apply for a moratorium under the Corporate Insolvency and Governance Act 2020, put together a restructuring plan or propose a company voluntary arrangement, all of which are processes designed to help businesses navigate disruption and emerge stronger.”

Ian McCulloch, partner at Opus Business Advisory Group in Preston, believes the recession is already here. He says: “These are tough times for entrepreneurs.

“They have battled through the pandemic, endured supply change disruption, changed their business models to reflect labour shortages and struggled to maintain profit margins as cost inflation rages and the cost-of-living crisis reins in their customers’ spending.

“Their balance sheets are battered, their finances are stretched and all they can see ahead is uncertainty. Things won’t get better for them without major change.”

He adds: “Restructuring should never just be about survival, but about carving out a revitalised business with positive prospects for profits and jobs.”

That means tough decisions must be taken. Ian says business owners need to think the “unthinkable and do the undo-able”. No aspect of their operations and finances should be untouchable. Every business is unique, so restructuring solutions will differ.

Ian says: There is no template. Nevertheless, there are common areas: cost cutting, improving profit margins, securing sufficient funding and raising talent and skill levels throughout the organisation are regular features of restructuring projects.

“Successful outcomes are as much about people as they about numbers. They usually involve creating a positive culture and clarifying responsibilities within businesses – giving real ownership of tasks to managers and their teams and ending top-down senior executive dictatorship.”

Transparency matters too. Ian says telling staff what is going on, sharing rather than hiding financial data, and seeking their input will make a “huge difference”.

He goes on: “Setting clear restructuring objectives is essential, as is working to a well thought-through plan, though in a flexible way to reflect the inevitable changes that will occur.”

Oliver Collinge is an insolvency practitioner based in the North of England. He says: “For struggling businesses, it’s not too late to begin negotiations with landlords and creditors to develop manageable repayment plans.

“Will revenues be high enough to support your cost base? Will cash flows be sufficient to deal with the additional debt burden, both formal and informal, that has accrued during Covid?

“Perhaps a CVA is something which should be considered or, where you may need to take the difficult decision to make redundancies to survive, consider applying for government funding to meet the short-term cash impact of this.”

Rosalind Hilton, insolvency practitioner at Blackpool based Adcroft Hilton, says: “Any restructuring has three things in its foundation: early intervention, realistic and achievable targets, and a good understanding of the company’s financials.”

She adds: “Too often, directors spend months firefighting, robbing Peter to pay Paul before asking for help.”

This can mean that many payments have been missed and that creditors chasing payment have been fobbed off with repeated promises of payment ‘next week’.

Rosalind says: “If these promises aren’t kept, then creditors quickly lose trust in the business.

As a result, they are unlikely to believe that the company will deliver on the future promises of a restructuring. If directors have lost credibility by breaking promises or failing to deliver, it is difficult for a business to recover.”

The second issue is being realistic about what is achievable. Directors can be keen to put difficulties behind them and as a result can be over optimistic about future trading.

Rosalind adds: “If cashflow has been poor for a while, there is no point making an offer based on a swift change in fortune. It can be difficult for directors to assess how long it will take for changes to take effect.

“Another key consideration is the directors’ understanding of the financials. If they don’t have a full grasp of the numbers and what they mean, professional support is essential.

“Ironically, incurring additional fees to have monthly or quarterly management accounts prepared can help directors focus on what is or what is not working and ultimately improve profitability.”

Whatever route is taken will be difficult. Ian McCulloch says: “Entrepreneurs tend to be good at creating and growing businesses, not dismantling them.

“Expecting them to junk product or service lines and turn away potential sales because they are too marginal or there is insufficient working capital is a tough ask.

“Sacrificing their sacred cows rarely comes easily. Management bandwidth isn’t infinite and rarely stretches to major projects like this.

“This is why it is vital to bring on board and work alongside tough, seasoned restructuring experts, who understand the art of the possible.”