Wednesday October 21, 2020

Debt Advisory Partner Tom Cox explores the options open to firms looking to refinance for their best chance of success in 2021.

The extent of the UK government’s coronavirus intervention schemes has been nothing short of monumental. As of the end of Q3, bank and government support for UK firms topped £100 billion – an extraordinary amount to fight extraordinary economic pressures.

While the various support schemes have gone some way to preserving liquidity and keeping the lights on through the most challenging moments of the pandemic so far, many firms will now be far more indebted than they ever intended to be. Some will be taking on debt funding for the first time. To provide some context, nearly 60 per cent of that £100 billion has been provided to businesses’ balance sheets by traditional lenders through the Bounce Back and Business Interruption Loan Schemes. With repayments beginning to fall due in 2021, the question on many business owners’ minds will be whether they risk jeopardising their business’ recovery in doing so.

Discounting those firms who will have tapped into support as a precautionary buffer, businesses will likely fall into two categories. Those that are not yet in a strong enough position to begin repayment and those that are recovering well but would see their growth impeded by servicing the debt in the mid-term.

Although refinancing could lead to more expensive headline interest rates, business leaders should be reviewing their options to rehouse or restructure their debt in the event that doing so will better suit their long-term recovery plans.

Chief among the reasons for doing would be to extend the length of the ‘recovery runway’ firms can use before taking off again. Such a runway may be better suited to the private credit market. Institutional lenders typically provide longer-term finance options at rates as low as six or seven per cent. Importantly though, they are more likely to structure the debt in a way such that repayment isn’t required until much closer to or, indeed, upon maturity. For those businesses in the early stages of a viable recovery, this approach could enhance cashflow to aid growth at a time when market liquidity is low.

A decade ago, the clearing banks held a much greater portion of the market, particularly among mid-market outfits. Fast-forward to today and between half and two-thirds of this market is being funded by private capital. There is a desire among these funders to generate greater returns and, naturally, they are willing to provide the flexibility to firms that can help them achieve their goals over a longer period. Indeed, with funds able to structure transactions with both a cash-paid and a non-paid, payment-in-kind (PIK), return instrument there are options available to preserve liquidity. While equity value for shareholders ultimately needs to ‘get ahead’ of this PIK in the longer term, it may provide the headroom a business needs in the next few years, alongside a non-amortising structure, to support re-investment and a return to growth.

Of course, some businesses won’t be showing enough strength in their recovery at present to be able to refinance their existing debt structure. As such, they will need to consider other areas of the alternative market. With several funds raising specialist ‘dislocation’ capital to deploy in the knowledge that the pandemic represents a unique scenario for shareholders, there is a clear expectation that some companies will need an alternative solution. Some funds can offer other financial instruments such a preferred equity which, while non-dilutive, may come at the price of a structural instrument ranking ahead of shareholders with lofty, albeit non-cash paid, return requirements.

As is expected in the alternative lender market, these funds offer a more expensive approach overall but, crucially, avoid handing over equity and control of the business to others in favour of short-term health.

Now is the time to review, adapt and evolve. Our team of specialist advisers are on-hand to support every step of your business journey, providing integrated and tailored guidance that empowers your business to prosper in the new economy. If you are keen to assess your options, please don’t hesitate to contact us.