Although there has been excitement over the emergence of green shoots, Rob Donaldson, Head of M&A and Private Equity at Baker Tilly, believes companies are still facing a tough time. “The best you can say about the economy is that things have stopped getting worse,” he says.
Certainly, hopes of a significant recovery by the end of this year seem overly optimistic. In a report issued on 15 June 2009, the Confederation of British Industry (CBI) acknowledged that the worst quarterly falls in Britain’s output were probably in the past, but warned that the return to growth was likely to be a slow and gradual one.
“Difficult credit conditions are still affecting business behaviour,” said CBI Director General Richard Lambert in the report. “For positive growth to return, lenders need to feel more confident, so that credit can start flowing again.”
On the plus side, at least the CBI doesn’t expect the economy to contract any further in 2009, but that’s not to say life has suddenly become easier for Britain’s businesses. Despite all the talk of green shoots, June also saw steel company Corus announcing plans to lay off a further 2,000 employees in response to falling demand, while British Airways sought to address some of its financial problems by asking staff to work for a month without any pay.
As Donaldson observes, for the time being at least, businesses should work on the assumption that the economic situation is unlikely to improve dramatically. While bank lending has been on the increase (driven in part by government pressure), finding new money is still a challenge. “Businesses are preparing to work within the current economic situation, using the cash they’ve got,” he says.
In many cases, that will mean taking action to address cash shortfalls to enable the business to continue trading effectively until the economy recovers. “There are,” says Donaldson, “a number of ways that companies can relieve the financial pressures caused by the recession.”
Reviewing costs
Perhaps the most obvious first step is to take a long, hard look at your cost base. “You should be going through your costs and challenging them line by line,” says Donaldson.
This can be a tough process. For one thing, it can involve facing long-held assumptions about what is and isn’t necessary within the business, and there may be vested interests to be confronted. This may mean staff up to senior board level compromising on their plans for the organisation. The key is to set about the task strategically. Whether you’re looking at staff (see page 14), research and development spending, or simply cutting out waste, you need to think of where you want the company to be when the recovery comes, and what you need to do to get it there.
Renegotiation
Companies shouldn’t be afraid to ask suppliers or customers to review existing contracts. “It’s something that a lot of businesses are reluctant to do, because they expect to get a negative response,” says Donaldson. “But you won’t know what the outcome will be until you ask.”
Renegotiation doesn’t necessarily mean asking a supplier or customer to accept a worse deal. For instance, there has been a trend among retail chains of seeking to pay rent monthly rather than quarterly. While the amount of cash changing hands remains the same, replacing a three-month upfront payment with a monthly arrangement can have a big impact on cash flow. As Donaldson observes, this can mean the difference between survival and failure. “You see a lot of retailers going bust before rent day, because they haven’t got sufficient money to cover a three-month payment,” he says.
Donaldson stresses that anything can be renegotiated, from the credit terms you offer customers, to photocopier supply agreements or IT service contracts. “Work on the principle, if you don’t ask, you don’t get,” he adds.
Asset disposals
Selling a business unit can bring in cash, while also freeing up management time to focus on core activities. “Now isn’t the best time to sell a business,” acknowledges Donaldson. “However, neither is it a good time to raise cash by borrowing or selling equity. So if you think that part of your business doesn’t really fit in with the rest of the company, a disposal may be a good idea.”
A recent Baker Tilly survey of finance directors found that around 26% of companies expect to make acquisitions in the coming months to position themselves for the economic recovery, so prospective buyers are out there. Meanwhile, although the level of M&A activity may be well down on last year, deals are still being done. Valuations are lower than was the case prior to 2007, but it is still possible for vendors to secure a good price.
Alternative sources of funding
The banking system has stabilised and the major high-street banks have responded to calls from businesses and the Government to increase their lending. Nevertheless, it is still not easy for cash-strapped businesses to access new credit arrangements. However, there are alternatives to the traditional lenders. These include funders such as Santander, Handelsbanken, KBC, Centric and the Co-operative. “These banks haven’t been affected by the international financial crisis to quite the same extent as the big names on the High Street,” says Donaldson. “They aren’t necessarily the banks that you think of first for business finance, but they are certainly worth considering.”
There has also been an increase in the amount of ‘alternative finance’ available over the last few years, ranging from asset-based lenders specialising in solutions such as invoice discounting and factoring, through to new lending funds set up by private equity companies.
Government schemes
One reason that the frozen credit markets have begun to thaw again is the implementation of government schemes designed to encourage banks to lend. These include the Enterprise Finance Guarantee (EFG), which can be accessed by businesses turning over up to £25 million a year. As with its predecessor, the Small Firms Loan Guarantee Scheme, the initiative is intended to free up lending by transferring some of the risk from the bank to the Government. As things stand, the Government will underwrite 75% of loans up to a value of £1 million.
However, it would be wrong to suggest that the scheme has made it easy for businesses to access bank finance. “The bank is still taking on some of the risk and will make its usual assessment about the viability of the company and the business plan,” says Donaldson. “Furthermore, companies still need to provide security.”
A second initiative, the Working Capital Scheme (WCS), underwrites up to 50% of bank loans. However, in contrast to the EFG, individual companies cannot approach a bank and apply for a loan under the scheme. Instead, banks decide which of their loans they wish to put into the WCS.
Finally, Lloyds and RBS, two banks that were hit particularly hard by the financial crisis, have signed up to the Asset Protection Scheme, which is designed to guard them against bad debts. In return for membership of this initiative, the participating banks have agreed to adhere to specific lending targets. “Taken together, all these government schemes have begun to improve the availability of finance,” says Donaldson.
Tax schemes
If bank lending proves impossible to arrange, cash flow issues can be addressed – at least temporarily – through the Government’s tax deferral scheme. This covers VAT, PAYE and corporation tax, and has been launched to help businesses with cash flow difficulties. But it’s not a free lunch. While the deferral period can be up to 36 months, companies are required to show that they will be in a position to make the payment when the time comes. “You will have to demonstrate to HM Revenue and Customs that the business is not failing, particularly if you apply for more than one deferral,” says Donaldson.
Restructuring
In situations where you have a good business, but a bad balance sheet, it may be appropriate to look at restructuring your business – either financially (renegotiating the repayment of money owed to creditors) or operationally. You could even consider a combination of the two.
The details of the restructuring process will depend upon the business circumstances. For those companies that identify a potential problem early, the first port of call is often the corporate finance adviser, who can help you run through the refinancing options.
In cases of serious financial stress, the larger accountancy firms, including Baker Tilly, have specialist recovery and restructuring practices. Financial restructuring often involves the bank either rescheduling debt or trading some of the loan repayment in return for equity. Lenders may require a commitment to operational changes, such as asset sales or redundancies.
The ultimate aim of all these measures should be to ensure that your business survives the downturn in good shape, to take advantage of the recovery, when it arrives.