Corporate insolvencies surging as distress continues to grow

UK companies are facing an incredibly difficult winter as the economic challenges that have pounded the country for close to two years now persist, with levels of financial distress soaring and corporate insolvencies on course for their highest levels since 2009.

This has all been a long time coming, the natural consequence of a slew of headwinds including the ongoing impacts of COVID-19 and Brexit, the massive levels of debt companies accumulated during the pandemic, supply chain chaos, soaring prices for energy, labour and raw materials, the fallout from the war in Ukraine and the knock-on effects of a cost-of-living crisis that has driven consumer spending down dramatically.

While it may have been predictable, the consequences of this crisis are still astonishing, with insolvencies at their highest levels since the aftermath of the financial crash and warning signs that tens of thousands more firms are tottering on the brink, heavily indicating that the situation will deteriorate before it gets better.

For many businesses, especially in sectors already badly hit by the prevailing economic headwinds such as retail and hospitality, this Christmas could be make-or-break and indications that consumer confidence remains low heading into the festive period will have huge numbers of company owners worried about their prospects.

Against this backdrop, many business owners will be exploring all possible avenues to keep their companies away from outright collapse, while others will be looking to get out altogether, following years of tough trading that, for some, stretch back to the Brexit vote – almost eight years ago now, in 2016.

While it may sound cynical to view this situation through opportunistic eyes, in truth, there will be thousands of owners out there right now who would be delighted to exit their business through a sale or by attracting the outside investment that could save their company.

Simply put, there are going to be thousands of eager sellers out there, while well-capitalised businesses looking to grow in ongoing adverse economic conditions cannot afford to ignore the wealth of distressed opportunities available on the market. After all, failing to grow and build resilience in such a tough environment could put even the most well-run businesses at risk.

Collapses surge as “wave of insolvencies” arrives on UK shores
Since the COVID-19 pandemic, there have been widespread forecasts (including our own) that the UK would be hit by a “wave of insolvencies”. Measures taken by the government during the pandemic propped up many businesses that would otherwise have collapsed, while simultaneously saddling these companies (many of whom were already struggling before COVID-19) with unmanageable levels of debt.

This created an army of “zombie companies” that were virtually destined to fall into insolvency when COVID support measures ended and debts taken on to stave off collapse during the pandemic needed to be repaid – but events since the pandemic mean that the situation is now worse than many would have predicted even back then.

While 2021 saw significant recovery for many businesses, as consumers revelled in the end of COVID-related restrictions, subsequent economic uncertainty has plunged many firms into even greater trouble.

2023 has, so far, seen a shocking fulfilment of many of the worst-case scenarios that have been outlined over recent years, with the UK on course for its highest level of corporate insolvencies since 2009 – the immediate aftermath of the financial crash.

Figures from the UK government’s Insolvency Service showed that more than 12,000 companies in England and Wales entered insolvency during the first half of the year, amid high inflation, soaring borrowing costs, falling consumer confidence and massive increases in the costs of energy, materials and labour.

The second quarter of the year, in particular, showed massive levels of distress, with 6,342 company insolvencies – the highest quarterly figure since Q2 2009. Significantly, 5,240 of these collapses were creditors’ voluntary liquidations – indicating a considerable degree of owner fatigue amid huge levels of debt and increasingly difficult trading conditions.

The third quarter showed a slight improvement, but no significant turnaround in the fortunes of UK companies, with 6,208 insolvencies between July 1 and September 30 – down 2 per cent from the previous quarter, but up 10 per cent from the same period a year earlier.

High levels of distress point to tough times continuing
While the slight fall in insolvencies represents a glimmer of hope for UK businesses (alongside the Bank of England’s decision to leave interest rates unchanged in its last two monetary policy decisions, following 14 successive increases), there is little doubt that 2023 has been the worst year for UK businesses in more than a decade and that thousands of companies still face huge uncertainty as we approach the beginning of 2024.

Although there are reasons for extremely cautious optimism, financial distress in the UK is continuing to rise, indicating that high levels of corporate insolvency will not be dropping any time soon. Begbies Traynor’s quarterly Red Flag Alerts have become the go-to guide for the state of UK businesses and the latest report makes for grim reading.

According to the Q3 Red Flag Alert, there are 37,733 UK businesses currently in “critical” financial distress (defined as when a business has County Court Judgements – CCJs – in excess of £5,000 filed against them), up close to 25 per cent from Q2 2023. Meanwhile, close to 480,000 businesses are classed as being in “significant” financial distress, up 8.7 per cent from the second quarter.

One of the most striking takeaways from the report was just how widespread the steep increase in distress has been and how much of the UK economy has been impacted, with Begbies Traynor reporting double digit increases in critical financial distress between Q2 and Q3 in 18 of the 22 sectors that the Red Flag Alert covers.

Critical financial distress, therefore, has moved far beyond consumer-facing sectors (which were among those initially hit hardest by rising costs and falling consumer sentiment) and into the majority of industries across the UK. For many observers, these figures reflect, not simply a turbulent blip in the economy, but a new economic reality that businesses must contend with: high inflation, high interest rates and low consumer confidence.

Again, higher borrowing costs amid soaring interest rates are seen as particularly critical, as debt laden companies now find it virtually impossible to access the working capital they might require to trade out of the current crisis.

Begbies Traynor Partner Julie Palmer commented: “Tens of thousands of British companies are now in financial dire straits now that the era of cheap money is firmly behind us. Businesses that had loaded up on debt at rock-bottom rates, and were only able to cling on during the pandemic thanks to Government support, must now deal with a financial reality check as higher interest rates hit working capital for the foreseeable future. Taken together with stubbornly high inflation and weak consumer confidence, many of these businesses will inevitably head towards failure.”

The sharp increase in distress across most sectors, with financial malaise also beginning to spread to larger companies, seems to support a prediction made earlier in the year by Begbies Traynor Chief Executive Ric Traynor, who forecast that current trading conditions would “wipe out” all zombie companies with unmanageable debts by the end of 2024.

Discussing the results of the latest Red Flag Alert at the beginning of November, Traynor stated that ongoing geopolitical uncertainty, high commodity and energy prices, stubborn inflation and interest rates, low consumer demand and the possibility of a recession over the next year “may simply prove too much for many of these distressed businesses.”

Despite stating that the recent stabilisation of inflation and interest rates may, “in due course”, see the rate at which distress is rising begin to slow, Traynor added that this is something that would take time – and time is not a luxury that the majority of businesses in financial distress have.

Pointing out that insolvencies often peak long after the start of an economic recovery, Traynor concluded: “So, given the challenges the economy still faces, the outlook remains pretty bleak, and I expect many more ‘zombie’ companies to continue to fail for some time to come as the impact of this economic backdrop makes them increasingly unviable.”

Construction signals the troubles facing firms
With its multitudes of micro, small and medium-sized firms, high exposure to economic headwinds such as cost inflation, supply chain disruption and low infrastructure spending, and the combination of high levels of debt and fragile levels of working capital that the majority of firms grapple with even during more forgiving economic times, the construction sector is often the worst hit by rising insolvencies and distress.

As such, the sector is often described as a bellwether for the overall state of UK businesses. True to form, the industry has been more heavily impacted by the current climate than any other sector and is among those leading the way in both insolvencies and financial distress.

The year started with many construction companies already on the brink. Begbies Traynor’s Red Flag Alert for Q4 2022 reported that there were slightly over 77,077 construction firms in significant financial distress (the third most of any sector, behind support services and real estate & property) and Begbies warned at the outset of 2023 that a “perfect storm” of headwinds could lead to more than 6,000 construction firms collapsing during the year.

While it remains to be seen whether this figure will be reached by the end of the year, there is little doubt that it will be close. In the 12 months to the end of Q3 2023, the construction sector registered a total of 4,276 company insolvencies – 18 per cent of total insolvencies in that time and the highest of any sector, according to the Insolvency Service. Last year, the construction sector was calculated to account for 13.5 per cent of all registered businesses in the UK, showing that the sector is being significantly disproportionately impacted by rising insolvency rates.

As we come to the end of 2023, the picture is deteriorating, rather than improving, for the construction industry. Between Q2 and Q3 2023, Begbies Traynor reported a 46 per cent increase in construction companies in critical financial distress (the biggest increase of any sector). Close to 6,000 construction firms were reported to be in critical financial distress, ahead of any other industry, while more than 72,000 were in significant financial distress.

Logistics hits a low
Over the past twelve months, 463 haulage businesses went bust, more than double the figure of 225 recorded two years ago. Accountancy firm Price Bailey discovered this astounding data last month through obtaining a freedom of information (FOI) report.

According to Price Bailey, the haulage sector has been squeezed by a convergence of adverse factors. These include wage and fuel price rises, general increases in overheads, plus interest rate hikes that have made debt servicing particularly difficult.

Retail illustrates Christmas fears - and signs of hope
As consumer confidence continues to deteriorate in the UK, no sector – with the possible exception of hospitality – is more heavily impacted by lower spending than retail. While it may not have suffered as much as construction in 2023, UK retailers have faced an exceptionally difficult year and, as 2023 draws to a close, the sector’s plight reflects many of the major concerns among UK owners – as well as some possible glimmers of hope.

According to the Insolvency Service, wholesale & retail and trade saw the sharpest increase in insolvency rates of any sector in the year to the end of Q3 2023. During that time, the sector, alongside the repair of motor vehicles and motorcycles sector (with which it is traditionally grouped in insolvency stats) showed 3,777 company insolvencies – 16 per cent of the UK total.

Like virtually every other sector, retail has been hit by high borrowing costs, inflation and interest rates, but particularly by low consumer confidence, which has seen sales plummet. Like the hospitality industry, with which it is intrinsically linked, retailers will be hoping and praying that the vitally important festive season (spanning from Black Friday through to the January sales), delivers the strong sales figures that could help turn their fortunes around.

As we enter this period, however, the signs are not good. The Red Flag Alert showed a significant increase in critical financial distress in the sector, with food & drug retailers seeing a 33 per cent increase and general retailers a 14 per cent rise compared to Q2 2023.

Overall, there were close to 4,000 general and food & drug retailers in critical financial distress, while more than 30,000 in the general retail category alone were in significant financial distress (the sixth highest-ranked sector in the report).

Against this already worrying backdrop, signs for the sector’s prospects heading into the Christmas period are likely to stoke even greater concerns among retail business owners. According to recently released figures from the Office for National Statistics (ONS), UK retail sales were down 2.7 per cent year-on-year in October, as the sector was hit by a multitude of headwinds.

Despite a Reuters forecast of a 0.3 per cent increase from September 2023 to October, sales actually fell 0.3 per cent, with sales at their lowest since February 2021 – in the midst of COVID-19 pandemic restrictions and during a month that is traditionally slower for retailers.

As well as slumping consumer confidence and broader economic uncertainty, retailers have also been hit by more variable factors, particularly weather. Wet weather seen across much of the summer and late autumn have had a particular impact on sales, while, conversely, the warm weather that the UK saw during September meant that sales of colder weather items – which often begin in earnest around this time of year – were significantly lower.

Meanwhile, rising fuel costs meant that shoppers had been less likely to visit out-of-town shopping centres and retail parks – a sub sector that has provided a major boost for retailers amid the decline of high street shopping.
These figures have led to concerns that the retail industry will be in recession heading into the festive period, amid forecasts that consumers will cut back their spending this Christmas, focusing on buying fewer and cheaper presents.

While many have sought to respond to this by beginning their Christmas campaigns early and targeting consumers with more price reductions, EY Item Club Chief Economic Adviser Martin Beck does not expect an imminent turnaround in the sector’s fortunes.

Quoted in the Guardian, Beck said: “The retail sector is unlikely to experience a significant uptick in fortunes in the near term. The impact of higher interest rates is building, with an extra 1.5 million households with mortgages set to see fixed-rate deals expire and roll on to higher rates before the end of 2024.”

However, despite the grim outlook, there are indications in the retail sector of better days ahead. While still high, inflation has begun to fall, while interest rate increases have – for now – been halted and wages are rising. This should lead to a concerted increase in real earnings, giving consumers greater spending power and, after so many months during which they have had to watch their budgets, this could spur a concerted return to the kind of spending that retailers and hospitality firms thrive off.

Another area has also been demonstrating the resilience of the retail sector: M&A. As we outlined in a recent insight, dealmaking activity in the retail sector has been strong this year and, crucially, this has not been mainly driven by opportunistic, distressed M&A. Rather, retailers seem to be viewing acquisitions as one of their best long-term options for driving growth, solidifying their operations and diversifying into more high-growth areas.

One of the major victims of the crunch on consumer spending has been home improvement retailers. While such businesses did solid business in the aftermath of COVID-19, as homeowners embarked on improvement projects they’d delayed during the pandemic, they were among the first businesses hit by factors such as rising costs, supply chain issues and falling consumer confidence.

This has resulted in many previously profitable businesses falling into administration – such as bathroom retailer Victoria Plum. Despite reporting pre-tax profits of £736,000 and turnover of £113.6 million in the year to February 28 2022, Victoria Plum, which was owned by private equity firm Endless, fell into administration at the end of September, citing the cost-of-living crisis and inflation of global freight costs.

Following the appointment of Ernst & Young LLP partners Samuel James Woodward and Timothy Graham Vance as joint administrators on September 29, the business and certain assets – including its head office, UK distribution network and workforce – were acquired by e-commerce retailer AHK Designs Ltd in a pre-pack deal.

While the deal was, naturally a distressed acquisition, AHK Designs Director Aamir Khurshid explained that it also was significant for his firm’s strategic growth plans. Khurshid said: "Victoria Plum is a leading online retailer of bathroom products with a strong brand and market-leading product. We are pleased to be investing in the future of the business and look forward to welcoming all of Victoria Plum's employees into AHK Designs."

This is by no means to say that retailers are out of the woods, of course. Many are in an incredibly perilous position and it is highly unlikely that any concerted recovery will occur prior to the all-important festive period. A great many retail businesses are all but certain to fall into insolvency, but there are signs that a recovery is beginning to take shape.

If, as expected, 2023 ends with a difficult Christmas for UK households, then any concerted improvement in earnings and spending power in 2024 is likely to yield a strong return to discretionary spending after so many months of frugality – similar to the recovery seen across many sectors following the ending of COVID-19 restrictions in 2021.

Distressed opportunities abound
Of course, the flipside of all of this uncertainty is that there are a wealth of undervalued and distressed acquisition opportunities on the market for buyers with the cash to do deals. While a great deal of businesses have failed or will fail because they are no longer viable (the aforementioned horde of zombie businesses), there are also a great many companies out there that, in less dire economic times, would be profitable operations.

Indeed, with early projection being made that the economy could improve (albeit slowly) in 2024, potential buyers have the opportunity now to acquire distressed businesses or assets at low valuations and then reap the rewards, should next year bring a return to growth.

As we’ve emphasised previously, the best deals – in terms of the value they deliver to the buyer – are often done during economic downturns. Furthermore, against such tight trading conditions, M&A activity is one of the only reliable routes to growth available to businesses.

As such, distressed acquisitions of high-potential businesses can be the perfect way for buyers to bolster their operations, expand into new areas and build the resilience they need to safeguard their businesses against ongoing economic turbulence. When levels of distress and insolvency are as high as they currently are, there are guaranteed to be thousands of good businesses that are staring down the barrel, meaning buyers have the opportunity to make potentially transformative acquisitions at a severely reduced cost.

R&W Civil Engineering is a Southampton-headquartered business founded in 1981 that provides civil engineering services, with a particular focus on the highways sector. Despite reporting turnover of £31.8 million in its accounts to March 31 2022 and operating profits of £895,000, the company fell into administration earlier this year as a result of the impact of COVID-19 and soaring inflation.

According to the company, its turnover had been hit by secured work being delayed due to COVID-19, before it was subsequently affected by “uncontrollable resource inflation felt across all elements of the construction supply chain”.
Clearly, this was a completely viable, previously successful business that had fallen into insolvency as a result of factors beyond its control. Unsurprisingly, the firm was quickly acquired out of administration by Octavius Infrastructure.

Far from being just another opportunistic distressed acquisition, however, the deal enabled Octavius to build on its strategy of using M&A to enter complementary growth, with the acquisition of R&W significantly bolstering its offering in the highways sector.

Discussing the acquisition, Octavius CEO John Dowsett revealed that R&W was a company that had been “identified in our acquisition strategy some time ago as a great fit both culturally and in terms of their complimentary capability.”

Dowsett continued: “Securing this acquisition supports our ambitious growth plans to become a market leading transport infrastructure provider.”

“The combined offering of Octavius and R&W has the capability to both self-deliver and integrate an SME supply chain to deliver a broad range of highway and civils projects for a variety of customers; from small reactive responses to large major projects, regionally and nationally, safely delivering these with a consistent collaborative approach that is underpinned by our aligned core values.”

Similarly, a retail sector collapse gave a company the chance to acquire a business it had previously targeted, when WoolOvers Group struck a deal to acquire footwear retailer Hotter Shoes out of administration in a £6.7 million pre-pack deal.

WoolOvers previously sought to acquire the company solvently in April 2023, but was outbid by a party that later withdrew their offer. Subsequently, following a strategic review of the business, it was placed into administration in July, enabling WoolOvers to make its move.

While many distressed takeovers involve the target being absorbed into the buyer’s own operations and brand, WoolOvers CEO Mike Lester said that Hotter Shoes’ status as a prominent footwear retailer meant that it would continue to trade as a standalone entity, through its existing network of stores and e-commerce site, with the buyer also planning to bring back the company’s mail order catalogue ahead of the Autumn/Winter season.

Lester commented: “We are trying to stabilise the business and to focus on getting the stock in place for autumn/winter. It’s a well-loved heritage brand and we want to get it up to where it was as quickly as possible.”

“We will start direct mail marketing again. Historically, the business has had a strong catalogue-driven business, driving traffic both online and into call centres. We plan to get that up [and running] for the autumn/winter season."

“We will continue to operate its own standalone ecommerce property and we intend to run the brand as a distinguished entity, and it wouldn’t be merged into WoolOvers. We absolutely plan to continue operating all the stores and concessions. We see them as a key tool to engage with the customers and a key part of the heritage.”

In late July 2023, business newspaper City AM fell into administration and was acquired by e-commerce technology group THG. The free paper, which was established 18 years ago, had established itself as a leading London business paper, with a daily run of 70,000 papers distributed from around 400 travel and commuter hubs and at approximately 1,600 London offices.

However, as COVID-19 put a stop to office-based work, City AM stopped printing its paper in March 2020. As a result of this loss of readership, the company was hit by declining ad revenues and, subsequently, rising printing costs when publication resumed. This ultimately led to it being placed into administration, before being acquired by THG in a pre-pack deal.

In August, it was revealed that THG had acquired City AM with an offer of £1.5 million and that the group was the only bidder, giving it a free run at a company that holds syndication partnerships with the likes of Bloomberg and Google.

Documents released by City AM’s administrators, BDO, revealed that the loss of readership during COVID - and the resulting fall in ad revenue - saw the company’s turnover drop from 61 per cent from £7.6 million in 2019 to just £3 million the following year, while it fell from a pre-tax profit of £218,000 to a loss of over £0.5 million in the same period.

After printing resumed in October 2021, the company recovered to report turnover of £3.7 million and a pre-tax profit of £59,000 during 2021. However, BDO said that it continued to face challenging trading conditions and, while revenue increased further to £6.1 million in 2022, it fell to a £584,000 pre-tax loss.

Efforts to secure additional funding subsequently broke down, prior to the company entering administration. A deadline of July 14 was set for offers to be submitted, by which time none had been received. However, on the deadline, THG made its offer to acquire the business and its assets, excluding liabilities, for £1.5 million.

BDO said the business and assets were sold "for an amount which exceeds the value that is likely would have been realised had the company ceased trading and the remaining assets (including intellectual property) sold subsequent to a winding up process".

Following the sale, BDO documents revealed that City AM’s secured creditors included Metro Bank (which was owned more than £750,000 of an £800,000 CBILS loan), SME Invoice Finance (SMEIF - which was owed £328,147) and HMRC (which was owed around £677,000).

Of these secured creditors, SMEIF and HMRC are expected to receive all their money back, while Metro Bank will receive between 44p and 75p in the Pound. However, unsecured creditors claim they are owed more than £2 million and the joint administrators have received claims totalling more than £2.36 million.

According to a recent report from KP Tech Corporate Finance (in which 73 per cent of dealmakers polled said they expected European M&A to increase over the coming year – compared to 53 per cent last year) the availability of distressed and undervalued acquisition targets was projected to be the biggest buy-side driver of activity, while, on the sell-side, distress was also predicted to be the biggest driver of exits.

It seems that, following a year which has again seen lagging M&A activity, there could be a significant recovery in dealmaking over the coming 12 months. While this may be a hesitant recovery (much like any potential economic growth), distressed M&A looks certain to be one of the main factors driving it. Buyers who are able to pick up solid assets at discounted prices could see a return on their investments relatively quickly, should the UK’s recent economic stabilisation turn into a concerted recovery in 2024.

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