The current economic climate is, at best, mixed for retail businesses and brands. In positive news, a number of value brands performed particularly well in the run-up to Christmas as customers "flock to value" in the face of the cost of living crisis. However, footfall on British high streets after Christmas was 27.7% lower. Inflation remains stubbornly high and the number of company insolvencies in November 2022 was 21% higher than in November 2021. The common factor to both sides of the story is that the landscape has changed and continues to change. That means that the future cannot be predicted with certainty and that previously "safe" assumptions for business and financial planning can no longer be relied upon as accurate. However, it also means potential opportunities for those sufficiently agile, alert and informed.
Change means opportunity
In times of economic turbulence, it is natural to view proactively managing or reviewing finance arrangements as inevitably a "bad news story". But this is often predicated on arrangements that were agreed upon in a different climate, when interest rates were lower, consumer spending patterns more predictable, and businesses had not adapted to the prevailing global shifts. Finance arrangements not reflecting the current landscape cut both ways for lenders and borrowers, and reviewing the suitability of existing arrangements can benefit both parties.
Different terms for different times
From a lender's perspective, lack of certainty and security means a lower risk appetite and, ideally, higher rates of return than those generated by arrangements put in place in a different climate. Wider economic changes may also prompt lenders to re-evaluate their loan books and to review more closely strict compliance with the finance terms that are intended to provide them with comfort and early warning signs of potential issues with a borrower. Terms that might not have been strictly enforced previously (e.g. reporting requirements) could now prompt business reviews, leading to exiting and/or renegotiating current arrangements. These are commercial decisions for lenders who are still looking for opportunities to provide debt; what has changed is their position on what meets that criterion. For a lender to properly assess the commercial position, they need to understand any relevant changes to a business which might not have been contemplated when the arrangements were put in place. For example, the market value of a borrower's physical premises may have been considered when assessing the ability to repay (and therefore the terms of the financing). Conversely, online sales which perhaps did not exist, or were less significant, pre-pandemic, may not have been. What was previously a key factor may have therefore diminished in value, and a new significant revenue stream may not have been taken into account, resulting in an inaccurate impression of a business.
Steps that borrowers can use to improve their position
It is the borrower who will understand their business the best. They will be acutely aware of operational changes made to accommodate global shifts in the economy, supply chains, workforce and consumer preferences. That gives a borrower a significant advantage, provided that they act on it. A proactive borrower will be best placed to:
(a) protect themselves from potential lender action, by (i) identifying commercial concerns that a lender might flag in a review of current arrangements and the steps a lender might be able to take in respect of any concerns, and (ii) by mitigating against any disruption; and
(b) identify opportunities to refinance on more suitable commercial terms, for example where current arrangements, and the assumptions underlying them, are no longer a good fit.
Even if a business is not struggling to meet its obligations, it is still good practice to review periodically whether arrangements remain commercially "fit for purpose". For example:
- If the current arrangement is asset-backed lending, does that remain the most suitable type of facility? Is it appropriate to review the valuation of those assets? In times of inflation not seen for many years, have those assets increased in value such that more favourable terms can be negotiated?
- Revolving credit facilities are traditionally popular with retailers due to their flexibility, and it is often the case that, in practice, they operate more flexibly than documented. Will lenders continue to tolerate that flexibility if conditions continue to deteriorate?
Key takeaways
Regardless of the approach that lenders and borrowers take, there are some key points to keep in mind:
- Understand your business and whether current finance arrangements properly reflect its needs. Do you fully understand your current operations, systems and processes (e.g. to track inventory), any changes in them and your finance requirements? Is the business paying for more flexibility or longer repayment terms than it needs? Has the basis on which the lender assessed the business's ability to repay debt (e.g. assets, how revenue is measured etc) changed? If so, are the current arrangements the most suitable or is there an opportunity to refinance on better terms?
- Clarity is essential. If the finance documents do not reflect the position in practice (e.g. historically, strict compliance with reporting requirements has not been required), do both the lender and borrower have the same understanding? If they don't, the lender may call what the borrower considers to be standard and accepted practice a default, triggering the right to take enforcement action.
- Defaulting on a loan is binary. There is no such thing as a 'technical breach' which does not trigger the same consequences as a 'substantive breach'. Even if events of default have not previously been enforced (or seem minor in nature), if the event has occurred, then, subject to any cure right, the lender has an unfettered right to accelerate the loan and enforce against any security. That may include a pre-existing breach. A nervous lender, or commercially unattractive terms in the current climate, could make this more likely.
- Understand your finance arrangements. What rights do the lender and the borrower have to take any action? What steps can they take, in what timeframe, and what triggers their ability to do so? Are there any potential challenges to those steps? Even if no preventative steps can or should be taken currently, understanding the landscape and having a "roadmap" is a protective step in itself.
Being proactive and properly informed is key to being in the best possible commercial position, whether that is responding to lender concerns or proactively identifying opportunities. Both borrowers and lenders are dealing with the same economic turbulence, so commerciality is the key. But, forming a properly informed commercial view on either side is impossible without properly understanding a borrower's business. A proactive borrower that can demonstrate their commercial financial understanding of the operation of their business pre-emptively is likely to give a lender more comfort and create a positive starting point for discussions, which in turn should create a commercial return.