SMEs at risk: Protecting against insolvency

SME Publications/ SME XPO 2024

By Tim Carter, Partner and insolvency expert, and Lucy Trott, Senior Knowledge Lawyer, at Stevens & Bolton

As the chill of recession bites for homes and businesses alike, SMEs are faced with the daunting prospect of navigating their way through the bleak mid-winter. In October 2022, inflation reached 11.1% and company insolvencies were 38% higher than the same period last year. Creditors’ voluntary liquidations in the same period were 53% higher than in 2019 (i.e. pre-pandemic), continuing the theme of businesses being forced to consider this terminal insolvency process, as following the pandemic they have struggled to adapt to the challenging market conditions.

Why are SMEs particularly at risk?

Given their relative size and profit margins, SMEs are particularly vulnerable to changes in consumer behaviour, reduced spending and a consequential drop in demand for non-essential products and services, which has been accelerated by the cost-of-living crisis. Coupled with increasing costs of materials, labour and energy, a perfect storm lies ahead for SMEs. The increases in interest rates in recent months (which is forecast to continue until mid-2023) will further squeeze cash-strapped businesses, who may already be tied into longer-term financial obligations which otherwise remain unchanged.

The government’s energy bill relief scheme, which freezes energy prices for non-domestic customers until 31 March 2023, will provide some relief to SMEs in keeping afloat through the difficult winter months in the hope of capitalising on (hopefully) a busy festive season. However, SMEs have little bandwidth to absorb record levels of inflation alongside increasing energy bills, and will need to be thinking further ahead as they find themselves navigating a crumbling economy and a reduction in consumer spending. Details of the government’s ongoing, more targeted support for vulnerable industries after the initial energy price freeze are yet to be revealed, and the extent and nature of the support unknown.  Businesses operating on the edges of solvency will need a plan in place to ensure they can meet their liabilities on an ongoing basis, without currently knowing how far government support will extend in 2023.

 How can restructuring help?

One of the ways in which smaller businesses flourished during the pandemic was through their ability to adapt to changes in consumer behaviour and restructuring their businesses to return to profitability. There are a number of tools that are potentially available to businesses, which depending on the level of their solvency concerns, might assist.

Company voluntary arrangements (CVAs) regularly made the headlines prior to the pandemic for their use in the casual dining and retail sectors. A CVA can prove a useful tool for businesses to reach a compromise with their creditors, and they are particularly valuable for businesses which operate from multiple (unprofitable) leasehold premises.

The new Part 26A restructuring plan was introduced in 2020 to enable businesses to restructure their debts and come to court-sanctioned compromise with creditors. It has not been particularly well utilised in the mid-market so far due to cost concerns, but a simplified version of the restructuring plan has recently been approved by the court in favour of a SME. This is a trend which could well continue as the courts and insolvency practitioners become more familiar with the flexible nature of this tool.

Alternatively, company administration can be an effective mechanism for rescuing the viable part of an underlying business which is otherwise unable to pay its debts and securing value for the goodwill and assets of the company. A pre-pack sale of the profitable elements of the business can sometimes be the best way to take forward the business in a more efficient and stream-lined manner.

Seeking early advice from an insolvency professional is key to finding the appropriate tool to assist businesses in navigating financial difficulty.

 Important points to remember

 It is particularly important in times of financial pressure for businesses to keep a close eye on cash flow and regularly produce forecasts so that any potential difficulties are spotted at an early stage.  Key suppliers, landlords and any lenders should be fully engaged in the event of any financial difficulties, as an open dialogue is key to seeking a compromise of any problem debts.  Businesses should be proactive in seeking any such support and may wish to take action pre-emptively, before issues come to a head – for example, by seeking to agree new payment terms with suppliers, restructuring existing bank lending or seeking a change to rental obligations under existing leases with landlords.

Seeking early advice and engaging with creditors and other stakeholders is crucial to ensure that the most appropriate strategy can be formulated before a business reaches the point of no return.

SME Publications/ SME XPO 2024