What would a base rate increase mean for business buyers?

The business landscape is changing; Britain has emerged from the recession and it's moving into a new stage of growth that is very different to the previous years of assured buoyancy that the country enjoyed. In fact, 2014 is shaping up to be 'all or nothing' as the gap grows between flourishing businesses and their downtrodden counterparts, so now more than ever buyers looking at distressed businesses and their assets need to take an active approach to their search if they want to capitalise on current trends.

It wasn't so long ago that we were reporting on the growing number of 'zombie' businesses operating in Britain; hundreds of companies limping along, able to pay off the interest on their loans, but unable to generate sufficient profit to make any considerable change or improvement to their situation. These businesses were described by the media and the insolvency industry as the walking dead due to the fact that any increase in the base rate by the Bank of England would have left them unable to meet their interest repayments and ultimately would lead to their downfall.

However, since the phenomenon was first highlighted the number of companies in this position has declined significantly. In fact, the latest data from insolvency industry body R3 shows that between June 2012 and August 2013 (the latest month for which figures are available), the number of zombie businesses in the UK fell from 146,000 to just 102,000.

It's tempting to presume that this either means that a clear improvement or decline in trading conditions has taken place across the board. But it looks more likely that a division is occurring. Although thousands of businesses are no longer classed as zombies, there has not been a corresponding increase in corporate insolvencies, leading those looking to snap up distressed businesses and their assets to enquire about what exactly has happened to these companies?

Liz Bingham, president of R3, has an idea: “Many struggling businesses will have used the unexpected grace period between recession and recovery to put their house in order, allowing them to spring 'back to life'.

“However, our research also shows thousands of businesses moving beyond 'struggling but surviving' into potentially dangerous territory.”

Further studies show that a record number of companies are currently being forced to negotiate payment terms with their creditors. Over 165,000 UK firms are facing this predicament, according to the R3 figures, while a further 96,000 businesses claim that they would be unable to repay their debts if the Bank of England introduced even a small increase in interest rates.

As the gap between successful companies and stragglers widens and more firms start on the path to stronger levels of growth, the likelihood of an increase in distressed acquisition opportunities is set to grow due to the increased possibility of the Bank raising the base rate.

It's true that some of the 96,000 firms that are currently teetering on the edge of solvency might still be able to chase their competitors back to healthy profit margins in time. But as the Bank's targets get ever closer, the zombie businesses that haven't managed to use the grace period to get back on track are set to collapse. Time is running out for these firms and savvy buyers know it.

Of course an increase in the base rate has always been on the cards, but the recent decline in unemployment is increasing the urgency in the situation. Last year, the Bank said that it would not consider raising the base rate from its current historic low of 0.5 per cent until unemployment fell to seven per cent or below. The unemployment rate dropped to 7.1 per cent in January, dragging the issue back into the limelight.

The Bank of England's director, Paul Fisher, responded to the matter, but was keen to downplay the likelihood of an imminent increase in the base rate, perhaps to avoid any rushed decisions among businesses. Fisher stated that although the unemployment data has been taken into account, an increase in the base rate is “still some way off”. He added in a speech at State Street Global Advisors in London: “Even if the seven per cent unemployment rate threshold were to be reached in the near future, I see no immediate need for tightening of policy.”

This delay in action is also due to the need to wait for other economic signals, such as export growth, to confirm that a broad level of improvement can be expected. No doubt businesses on the edge will be hoping that the Bank will hold out for economic output to improve; at the moment it remains two per cent below its 2008 output levels.

The Bank of England has kept the base rate at 0.5 per cent since 2009. So when it finally is increased, the shift in market conditions will be more palpable than in other years. At one end, businesses that haven't managed to catch up will risk being wiped out, while at the other end, growth looks set to take on a new level of strength, widening the gap between success and failure and leaving those stuck at the bottom with a very difficult task indeed if they want to try and climb the ladder again.

Exactly what form these changes will take remains to be seen, as R3's Bingham remarked: “Whether or not there is an insolvency 'spike' still to come depends on the fortunes of those companies that are negotiating with their creditors or who would be unable to pay their debts if interest rates were to rise.

“A genuine ‘spike’ in insolvencies may now be unlikely, but there could well be a prolonged period where corporate insolvency numbers are higher than where they might typically be, so long after a recession.”

One this is clear: The shift has created a change in the business atmosphere and it is increasingly becoming an 'all or nothing' market where the middle ground is no longer an option. But for successful operators within the M&A market, particularly buyers with an eye on distressed acquisitions, this change could well deliver a number of opportunities to capitalise on competitors' failures by snapping up businesses and assets as firms hit insolvency.

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