What the government might do about the looming SME debt crisis

It’s not quite as catchy as its namesake, but the tune on the lips of many Treasury officials is “How to solve a problem like the SME toxic debt crisis”.

After countless small businesses were bailed out by a combination of the furlough scheme and bounce back loans, a debt crisis is looming large on the horizon as government support is removed and loans need to be repaid.

With government figures showing that 5.8 million of the UK’s 5.9 million private businesses having less than 49 employees, SMEs going bankrupt on this scale would have a huge impact on the overall economy and employment figures.

This article will examine the scale of the issue and look at possible solutions, including the “student loan” style repayment system that is currently being examined by the Treasury.

What is the UK’s small business debt crisis?

While COVID-19 has negatively impacted almost every part of the UK economy, the UK’s SMEs have been hit especially hard.

Indeed, figures from insolvency practitioners Begbies Traynor revealed that a record 527,000 businesses are in significant financial distress, the majority of the UK’s small businesses are just about surviving.

There are three key reasons for this:

• The Coronavirus Job Retention Scheme – Otherwise known as the furlough scheme, this has been a vital lifeline for business across various sectors. As of 19 July, government figures indicate that 1.2m employers have used the scheme, furloughing a total of 9.5m jobs.
• Bounce Back Loan Scheme – This has also been hugely important for SMEs, making sure they have the funds to get through this extremely difficult trading period. Official statistics indicate that, as of 19 July, over 1m small businesses have successfully applied for a business loan under the scheme.
• Tax deferrals – Many small businesses have also benefited from being able to defer their self-assessment or VAT tax payments for three months.

However, all these schemes are now coming to an end – the furlough scheme is being gradually wound in and will close for good at the end of October, businesses will need to start repaying their bounce back loans from 31 March 2021, and the tax deferral scheme finished on 30 June.

All this is occurring against the backdrop of a national economy that, depending on who you ask, is either gradually recovering from the impact of COVID-19 or still in the midst of a crisis. For almost all SMEs, consumer confidence is key – and a recent survey by market research group GFK found that it remains low due to health concerns and the risk of redundancy.

What all this means is there’s a high chance that many of the UK’s small businesses won’t be in a position to start repaying their bounce back loans in March 2021, meaning a huge pile of “toxic” debt (debt that is unlikely to be repaid).

How big?

In “Supporting Economic Recovery – Recapitalising Businesses post COVID-19”, a detailed report on this issue, banking lobby group TheCityUK suggest that, by the end of March 2021, we’ll have the following situation.

• £35bn of unsustainable debt owed by UK businesses from government loan schemes
• £100bn of total unsustainable debt owed by UK businesses

It’s a crisis that largely reflects the compromises that have to be made when crafting policies to deal with sudden events like pandemics. Companies across the country needed cash rapidly and no one had the time or inclination to do detailed financial checks on how these businesses would eventually pay the money back.

What will happen if no action is taken?

According to the TheCityUK report, if nothing is done, then it’s likely that 780,000 SMEs will be at risk of going bankrupt (and defaulting on their loans) at the end of March 2021, threatening three million jobs across the UK.

And, as it stands, the government wouldn’t stop this.

So, if your business struggles and you can’t pay back your loan, you still go out of business but the lender (i.e. the bank or finance company that gave you the money) gets the money back from the government.

And, with the furlough scheme expected to be withdrawn at the end of October and a second wave of COVID-19 possible in the autumn, SMEs could feel the full force of this economic reality long before March 2021.

What could be done about the debt crisis?

Under the current regulations, responsibility for chasing up businesses who are struggling to pay back their coronavirus loans falls on the banks and other lenders. However, it’s a role they want to avoid at all costs – it doesn’t take much imagination to see that hard-line enforcement tactics (like calling in bailiffs) would be frankly terrible PR and result in them being vilified in the national press.

To avoid this, TheCityUK (which represents many of these lenders) has come up with a plan that would save many of these businesses by introducing a completely different repayment scheme. However, the proposal is controversial – with some suggesting that it would create “zombie companies” artificially propped up by the government.

TheCityUK is arguing for the following:

• A Business Repayment Plan for very small businesses that would let them pay back their coronavirus loan via a long-term “student loan style system” where small repayments are made every month via the tax system
• Business Recovery Capital for larger small businesses – this would convert the coronavirus loan into a long-term unsecured loan that can be gradually paid back by the business

(Under TheCityUK plan, some larger businesses would also be able to convert their loan into shares in their companies and pay regular dividends, but this is unlikely to apply to many SMEs)

All of this would be overseen by a proposed UK Recovery Corporation that would, in conjunction with the UK government, administer these repayment schemes.

Overshadowing all this is the very real possibility that much of this corona debt may have to eventually be written off as the cost of the UK’s economic recovery, an approach Richard Hughes, the new head of the Office of Budget Responsibility (OBR), has advocated as possibly the only way to save the UK economy.

Similarly, Mike Cherry, the National Chairman of the Federation of Small Businesses (FSB) recently suggested that small businesses should only have to repay their coronavirus loans once they’re turning a profit:

“A guarantee that they [small businesses] won’t have to start making repayments until they’re turning a profit would give them the confidence to invest and hire today, rather than further down the line when such activity may prove too little too late.“

Others though advocate a more Darwinian approach to business survival.

Micheal Buckworth, the managing director of Buckworths, a legal firm that works exclusively with startups and high-growth businesses, argues that lenders are just trying to shift their obligations on to the government and that adoption of TheCityUK scheme would harm the UK economy overall:

“This plan risks the continuation of zombie companies that will never really grow or become profitable but will survive using up resources of talent and money if their debt liabilities are effectively suspended. There’s an argument that it’s better for the economy in the long-term for businesses that cannot achieve profitability to fail.

“While a student-loan style scheme may help lessen the effects of a recession and reduce unemployment in the short term, it isn’t sustainable as a long-term solution.”

What does the government think?

The Treasury has confirmed that it is closely examining the plan proposed by TheCityUK, but it remains to be seen whether it will adopt any of the measures outlined in it.

In a sense, this issue is a key test for how interventionist this Conservative government will be going forward – the unprecedented challenges of the coronavirus pandemic called for unprecedented government support but deciding exactly when and how the tap should be turned off will have a huge impact on the fortunes of hundreds of thousands of UK SMEs and the UK economy.

With a proper budget planned for the autumn, all eyes will be on Rishi Sunak once more.

Key points for your small business

• Many of the schemes that have supported UK small businesses, such as the furlough scheme and bounce back loans, are coming to an end
• Small businesses that received bounce back loans are supposed to start paying them back at the end of March 2021
• However, with the UK economy still recovering from the impact of COVID-19, many are unlikely to be able to do this
• This could have huge consequences – with up to 780,000 SMEs at risk of going bankrupt and three million jobs at risk
• To avoid this, financial lobby group TheCityUK have proposed a plan where the loans could be paid back over a long period of time – either through the tax system or by being changed to a long-term unsecured loan
• The Treasury is considering the plan, but some are concerned it could create “zombie companies” and harm the UK’s long-term economic recovery
• With the furlough scheme due to be withdrawn at the end of October 2020, many are expecting an announcement on this issue as part of Rishi Sunak’s October autumn budget