If a company is unable to pay its debts, it is deemed insolvent. Whether it is due to a cash flow crisis or a loss of a business contract, data shows insolvencies are on the rise.
Why insolvencies are at an all-time high
Corporate insolvencies in England and Wales have reached their highest level in 30 years. According to the Insolvency Service, the total number of company insolvencies last year was 25,158, the highest number since 1993 and 14 per cent higher than in 2022.
And according to the Centre for Economics and Business Research, this is not set to improve in 2024, as it has forecast more than 8,000 insolvencies per quarter this year.
This all points to many businesses across the UK being on the brink.
Some sectors are more affected than others. According to Insolvency Service data from 2023, construction was the most affected sector, followed by wholesale, retail trade and the motor vehicle repair sector, with the accommodation and food service industries struggling too.
For the year ahead, I predict that those industries will continue to feel the pressure, with additional sectors including hotel, leisure and transport, and storage expected to suffer too.
Unsurprisingly, one factor behind these rising insolvencies is the continued impact of the pandemic. With government support measures in place during the pandemic in 2020 and 2021, insolvency numbers were low, as these loans were propping up businesses.
However, in 2022, as these measures were rolled back, the number of creditors’ voluntary liquidations increased to exceed pre-pandemic levels.
While insolvencies can sound complex, ultimately it comes down to cash flow. Businesses reach insolvency when management and directors overreach. The Insolvency Service said one of the biggest drivers of these figures from 2022 was action by HMRC, which has increased the number of winding up orders for unpaid tax in recent months.
However, cost inflation is the major factor that drove record numbers of corporate insolvencies last year. In particular, we saw energy bills surging, and businesses are suffering through stagnation.
In a survey by PwC, 72 per cent of companies predicted negative repercussions on their profits due to rising energy costs.
For the manufacturing sector, which has been one of the more vulnerable industries for insolvencies, higher costs for electricity, gas or fuel for energy-intensive companies has brought huge pressure.
In addition to these factors, many sectors saw substantial increase in salaries, costs, materials and rising rent prices.
Tighter and more costly lending on finances is also adding salt to the wound for businesses, who are facing less access to capital and liquidity at a time when they need it most.
With reduced appetite for lending from high street banks, businesses are turning to secondary lenders who come with higher interest rates – often higher than these businesses can manage.
Whether you are a director, management, secured lender or even a landlord, it is important to know where you stand when an insolvency occurs and how best you can look after your own position.
Facing insolvency? Acknowledge it and act early
If your or your client's business is struggling, it can be tempting to bury one's head in the sand, but the key is getting advice early.
Businesses are not being helped by the economic climate, but good and effective management should be able to exert market understanding and navigate these issues. Yet, we continue to encounter directors who do not realise how close they are to an insolvency.
The earlier interventions are taken, the more solutions there are, such as securing financing on better terms, allowing more time to engage with shareholders, suppliers and creditors.
There are also practical factors to consider; the earlier directors take advice, the more options a business will have. It is critical to know what those options are as soon as possible.
Nowadays, against the economic backdrop, anyone trading has to be more conservative and even well-managed businesses can find themselves in difficult situations. Having assessed those options, communication is the next important step, providing clear and credible information to those that matter as soon as you are able. All of this is easier to collate and deliver ahead of time, rather than when the business is about to hit the buffers.
Directors and management are not the only ones affected by insolvency. Employers must consider their workforce too, for example which employees are critical to the business and where rationalisation might save the business. It is important to be clear and decisive on these issues.
It will not always be practical to follow an extensive dismissal process to exit an employee and there is always the potential danger of claims against the business in any event. In these cases, settlement agreements can present a commercial option to save management time and reduce risks.
Where the buck stops
When an insolvency occurs the liquidator will scrutinise every decision made, and with directors and management ultimately responsible for those decisions you need to be confident they are sound, or else risk finding yourself in the firing line.
Instructing a firm that can help manage both the insolvency and your personal risk is key. Look for legal partners with experience in financial distress and insolvency, as well as those that can support you with concerns around personal risks and future roles.
Final thoughts
While insolvencies can sound complex, ultimately it comes down to cash flow. Businesses reach insolvency when management and directors overreach.
Nowadays, against the economic backdrop of tighter lending and cost inflation, anyone trading has to be more conservative and even well-managed businesses can find themselves in difficult situations.
Despite this, the rise in insolvencies should not deter entrepreneurs; it is those new businesses and tapping into growth sectors that will help our economy boom. And it is positive to see eight in 10 (79 per cent) of small business owners expect to grow their business over the next 12 months.
Ultimately, it is all a question of balance. While optimism is important, there also needs to be proactive steps in place to mitigate risk, and getting in as early as possible and seeking advice is key.
Time is of the essence for sculpting those effective communication strategies to engage and persuade stakeholders to give companies more time and money, as well as building confidence and trust back up.
The tide is going out and if directors do not want to drown, they need to ensure they grab that life raft before it is too late.
Roger Hutton is a partner in business insolvency and restructuring at Clarion
