How to get your business out from under the COVID-19 debt mountain

Growth businesses face owing £105bn in debt because of COVID-19. Angus Grierson shows the various ways you can escape the debt mountain

What does the COVID-19 debt mountain look like?

The pandemic has resulted in an unprecedented COVID-19 debt mountain for SMEs and mid-market companies, with recent estimates reporting this could exceed £105bn by March 2021.

To help struggling companies, the government has introduced two main stimulus initiatives: the coronavirus business interruption loan scheme (CBILS) and coronavirus large business interruption loan scheme (CLBILS), with the latter aimed at larger companies.

While these measures are laudable and necessary, there is a fear many of the resulting government guaranteed loans will be unsustainable.

According to TheCityUK, £36bn in Covid-19 emergency loans to small businesses are at risk of turning toxic. To make matters worse, even before the crisis, UK SMEs faced £23.4bn in late payments, creating a vicious cycle as the pandemic struck.

To address this challenge, TheCityUK has established a Recapitalisation Group (RCG) which is working to understand and identify mechanisms to support the recapitalisation of UK businesses which have needed to take on additional debt in response to Covid-19. On June 8, RCG published an interim update that set out the scope of the challenge, considers the sectors most likely to need support, explores how private sector capital could be mobilised and identifies gaps that could remain for the public sector. It also discusses key challenges for any proposed solutions to ensure they work for business right across the UK. RCG then plans to publish final recommendations in July.

>See also: BGF pitches £15bn growth fund for struggling businesses post-coronavirus

In a separate recapitalisation plan being considered by the Treasury, a report by the Social Market Foundation think tank recently proposed a coronavirus recovery fund under which the taxpayer would take stakes worth £15bn in small firms.

There’s no doubt that businesses will be looking to address their debt levels, both now and in the months of recovery to come. However, companies shouldn’t be too pessimistic as there are various ways they can do this, from refinancing existing debt to other options such as exchanging debt for equity.

What are the loan options available to my business?

Businesses can first apply for the two main government measures that have been established to support companies during the crisis, CBILS and CLBILS.

CBILS provides an 80 per cent government guarantee on loans to firms with turnovers of up to £45m, and the first 12 months of interest and lender-levied fees are covered by the scheme.

CLBILS provides finance to mid-sized and larger UK businesses with a turnover greater than £45m. As of May 26, the maximum amount available through CLBILS has increased from £50m to £200m, although companies borrowing more than £50m through CLBILS will be subject to further restrictions on dividend payments, senior pay and share buy-backs during the period of the loan. The British Business Bank has now accredited 16 CLBILS providers, including challenger banks such as Metro Bank, OakNorth Bank and Secure Trust Bank.

Can you approach existing lender(s) about new, more favourable terms?

Absolutely. Companies not only can, but they should. Existing lenders know better than any other party about an existing client’s business situation as the relationship is already established, making discussions over refinancing much easier. So, if a company already has a loan from a particular bank or other lender, management could be well advised to seek to renegotiate repayment terms with its existing lender.

>See also: Jim O’Neill calls for £25bn post-coronavirus patient capital fund

What about taking on private debt?

For companies looking to raise money quickly to adapt to Covid-19 or take advantage of new opportunities, private debt is a highly flexible alternative and includes medium-term note (MTN) programmes and direct lending facilities. But the landscape is complex, and businesses need to understand what different products offer and which are most suitable for their requirements.

Given the funding gap in the private debt market for SMEs and mid-market companies, MTN programmes – traditionally used by larger companies – can be helpful. In the institutional debt markets MTNs are often used by banks and the financial subsidiaries of companies to meet varying funding needs. Similar to a bank facility, MTN programmes use common documentation for recurring borrowing up to a programme limit. However, borrowing is conducted under the terms of a negotiable note instrument that is placed with investors including wealth managers, family offices and institutions. A programme can therefore accommodate complex capital structures and the borrowing of large or small amounts. LGB has established more than 20 such MTN programmes across a range of sectors and borrowing requirements, demonstrating how they are an attractive option for SMEs.

What about specialist funds?

Another direct lending financing option is to target funds, which invest insurance and pension money in businesses and are able to take longer-term positions than conventional lenders like banks. The funds tend to offer a faster approval process than banks, and have more flexible credit structures than, say, P2P loans. However, they also have the opposite problem: the vast majority of credit funds cater to larger borrowers seeking event-based financing, such as acquisitions, making them unsuitable for smaller businesses that need working capital or an injection of funds to support the development of new products.

Are newer financing alternatives worth considering for SMEs?

Since the 2008-2009 financial crisis, alternative financing institutions have emerged at pace. Initially they were looked upon with concern, given lighter regulations, and certain failures in the peer-to-peer lending sector which did not help their reputation. More recently, the sector has matured and gained increased credibility as FCA regulatory oversight has tightened.

The FCA has made great strides in recent years to ensure alternative providers follow similar regulatory parameters as traditional lenders. The latest example being that alternative providers need to operate within the same “Lending Board Standards” as traditional banks. Other steps taken to ensure improved regulation of alternative finance providers include greater transparency and further reviews of the sector by the FCA.

Each alternative lender tends to focus on certain sectors and types of lending. For example, some alternative lenders specialise in invoice finance or funding particular assets.

How about asset-backed lending?

Asset-backed lending can also be an avenue worth exploring if cash flow is tight. These facilities are principally offered by mainstream banks that have dedicated asset-based finance arms, though other, younger providers have emerged to also compete in this area.  According to the World Factoring Yearbook published by BCR, the value of factoring and invoice discounting provided has risen significantly in recent years, whilst the number of businesses using such facilities has remained largely static. This suggests that funding providers are focusing on larger borrowers with better credit quality.

How do you decide if an alternative finance provider is right for your company?

Certainly, the starting point is to decide what kind of financing is being sought. Alternative providers offer an array of options including working capital financing, bridging loans, invoice financing and asset finance to name just a few of the types of finance on offer. Potential borrowers should then be reviewing the regulatory and market standing – and track record – of the alternative providers being considered. Other considerations include the speed at which the finance is needed, or whether the cost of the loan more important. Similarly, does the company have the cash flow to service the loan, or is the priority agreeing a loan facility that can be secured on assets?

Should companies be using invoice discounting or factoring?

Companies should also bear in mind they can raise funds quickly and improve cashflow either through invoice factoring or invoice discounting. These are where a company effectively sells outstanding invoices to a third-party in exchange for an immediate advance that is slightly less than the value of the invoices. Once seen as a last resort for companies, the market has continued to grow in recent years and total yearly advances in the UK have climbed to a record £22.7bn. And, though the number of businesses using invoice finance has remained largely constant, rising advances suggest that larger SMEs with more better credit quality ratings are increasingly taking advantage of these facilities.

How can venture debt facilities help businesses?

The government’s furlough and loan guarantee schemes reflect the pressure that growth businesses face in the current financial climate. Early stage businesses are among the worst affected as they often have yet to build up enough cash flow to be able to secure loans from more traditional financial institutions.

Unlike traditional bank lending, venture debt can be made available to SMEs and mid-caps which don’t necessarily have positive cash flows yet, but the providers would likely want warrants over a certain portion of the company’s equity.

Venture debt can also be an important source of growth capital and can function as a replacement for equity investment rounds and even fund M&A activity, which we are continuing to see occurring through discussions held remotely at both SME and multinational levels during the lockdown as smaller firms seek solutions to short term liquidity issues and larger players move to take advantage of consolidation opportunities and asset re-pricing.

Are there other ways of refinancing existing debt?

There are many alternatives available. These include accessing the private debt capital markets through bond and note programmes, and considering specialist non-bank lenders such as credit funds and family offices which are increasingly direct providers of credit facilities to companies, and which have an opportunity to differentiate themselves in the current environment by acting swiftly and transparently to support borrowers. At LGB Corporate Finance our debt capital markets team advises companies seeking liquidity, including from alternative lenders, and also establishes note programmes for them. These programmes are funded by family offices, wealth managers and institutional credit investors. Our latest deal was securing a £20m MTN facility for asset-backed lender Simply Asset Finance, helping to increase the company’s lending capabilities to growth businesses. So far, we have established MTN programmes with a total value of over £100m.

A further factor for businesses to consider is that the government’s recent issue of negative yielding bonds – where investors will see a negative return on government borrowing over a three-year gilt issue – could push investors into the corporate fixed income markets as they seek real returns. This is likely to enhance demand from investors for bond and note issues by companies whose businesses are well structured to withstand the immediate impact of COVID-19, so is a worthwhile option to consider in the current financial climate.

What are debt for equity swaps?

Debt for equity swaps can be a helpful path for growth businesses exploring means of restructuring their debt commitments. For businesses receiving support under the government’s Future Fund, this offers a viable way of receiving vital coronavirus funding without facing the potential anxieties of high debt costs, as outstanding repayments on the loan facility will be eligible to be exchanged for equity.

Certainly, many companies are facing a time of uncertainty, but this shouldn’t mean that businesses can’t take advantage of the lockdown period to re-assess their existing debt structures and, equally, to explore potential opportunities for refinancing their debts to help put them in a better position to boost their growth. We believe that high quality advice and access to a broad range of capital providers will be essential for growth businesses seeking to survive and then thrive post-Covid-19.

Angus Grierson is managing director at LGB Corporate Finance

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