Counting the costs

SMEs hit hard by the pandemic must now grapple with the economic fall-out of the war in Ukraine, signalling fresh uncertainty for the year ahead, so what’s the best plan of action?

COVID-19 lockdowns, global supply chain disruption, inflationary pressure – and now the economic fallout from the Russian invasion of Ukraine. 

The headwinds facing Ireland’s small- and medium-sized enterprises (SMEs) show no signs of easing as we enter the third quarter of 2022.

Even as the year began, the imminent winding down of Government supports for COVID-hit businesses was already prompting speculation of a spike in insolvencies just around the corner.

Now, Gabriel Makhlouf, Governor of the Central Bank of Ireland, has called on a “patient” approach from policymakers and creditors to help ensure that “unnecessary liquidations of viable SMEs are avoided over the coming months.”

Speaking at a recent event in Dublin co-hosted by the Central Bank of Ireland, Economic and Social Research Institute, and the European Investment Bank, Makhlouf pointed to the need to “channel distressed but viable businesses towards restructuring opportunities and unviable businesses towards liquidation.”

Uncertain outlook

For those SMEs in the sectors hit hardest by the pandemic, the fresh economic turmoil sparked by the Ukraine invasion will be a cause for concern.

“The outlook right now for SMEs generally in Ireland is very hard to determine,” said Neil McDonnell, Chief Executive of the Irish SME Association (ISME).

“It will vary considerably from sector to sector, but after two bad years for hospitality and tourism due to the pandemic, the war in Ukraine is likely to mean volumes will remain low into the summer.” 

Pandemic-related insolvencies have yet to spike. Research released by PwC in February found that Government support had saved at least 4,500 Irish companies from going bust during the pandemic, representing an average of 50 companies per week during the period.

Insolvency rates are likely to rise in the months ahead, however, as pandemic supports are withdrawn from businesses with significant debts, and PwC estimates that there is a debt overhang of at least €10 billion among Ireland’s SMEs, made up of warehoused revenue debt, loans in forbearance, supplier debt, landlords, rates and general utilities. 
“Government supports have to end at some point. We realise this, but it will be accompanied by a significant uptick in insolvencies. This is natural and to be expected, since 2020 and 2021 both had lower levels of insolvency than 2019,” said Neil McDonnell.

“Aside from hard macroeconomics, however, we can’t ignore the element of sentiment in how businesses will cope. This is the third year in a row of bad news.”

Confidence in the market

Before taking on his current role as Managing Partner of Grant Thornton Ireland, Michael McAteer led the firm’s advisory services offering, specialising insolvency and corporate recovery.

“What I’ve learned is that you really cannot underestimate the importance of confidence in the market,” said McAteer.

“If we go back to 2008 – the start of the last recession – or to 2000, when the Dotcom Bubble burst, we can see that, when confidence is lacking, the pendulum can swing very quickly.

“If you’d asked me a few weeks ago, before the Ukraine invasion, what lay ahead for the Irish economy this year, I would have been much more optimistic than I am now.
“Yes, we were going to see some companies struggling once COVID-19 supports were withdrawn, particularly those that hadn’t kept up with changes in the marketplace that occurred during the pandemic, such as the shift to online retail – but, overall, I would have been confident. Now, it is harder to judge.”

Government supports

Neil McDonnell welcomed the recent introduction of the Companies (Rescue Process for Small and Micro Companies) Act 2021, which provides for a new dedicated rescue process for small companies.

Introduced last December by the Department of Enterprise, Trade and Employment, the legislation provides for a new simplified restructuring process for viable small companies in difficulty.

The Small Company Administrative Rescue Process (SCARP) is a more cost-effective alternative to the existing restructuring and rescue mechanisms available to SMEs, who can initiate the process themselves without the need for Court approval.

“We lobbied hard for the Small Company Administrative Rescue Process legislation. The key to keeping costs down is that it avoids the necessity for parties to ‘lawyer up’ at the start of the insolvency process,” said McDonnell.

“Its efficacy now will be down to the extent to which creditors engage with it and, of course, it has yet to be tested in the courts. We hope creditors will engage positively with it.”

McDonnell said further government measures would be needed to help distressed SMEs in the months ahead.

“We already see that SMEs are risk-averse at least as far as demand for debt is concerned. Now is the time we should be looking at the tax system to incentivise small businesses,” he said. 

“Our Capital Gains Tax (CGT) rate is ridiculously high, and is losing the Exchequer potential yield. Our marginal rate cut-off must be increased to offset wage increases. 
“Other supports, such as the Key Employee Engagement Programme (KEEP) and the Research and Development (R&D) Tax Credit need substantial reform to make them usable for the SME sector.”

Advice for SMEs

For businesses facing into a challenging trading period in the months ahead, Michael McAteer advised a proactive approach.

“The advice I give everyone is to try to avoid ‘being in’ the distressed part of the business. By that, I mean: don’t wait until everything goes wrong. 

“Deal with what’s in front of you – the current set of circumstances and how it is impacting your business today. 

“Ask yourself: what do I need to do to protect my business in this uncertain climate, and do I have a plan A, B and C, depending on how things might play out?

“Once you have your playbook, you need to communicate it – and I really can’t overstate how important the communication is. 

“Talk to your bank, your suppliers, creditors, and your employees. Sometimes, we can be poor at communicating with our stakeholders. We think that if we keep the head down and keep plugging away, it will be grand. 

“By taking time to communicate your plans and telling your stakeholders ‘here’s what we intend to do if A, B or C happens,’ you will bring more confidence into those relationships and that can have a really positive impact on the outlook for your business.

“Your bank, your creditors and suppliers are more likely to think: ‘These people know their business. They know what they’re doing.’ If something does go wrong, they know that there is already a plan in place to deal with it.”

Role of accountants

Accountants and financial advisors will have an important role to play in the months ahead as distressed SMEs seek advice on the best way forward.

“We are about to experience levels of inflation we have not seen since the 1980s. This will force businesses to address their cost base and prices,” said Neil McDonnell.

“My advice to SMEs would be: talk to your customers, to your bank, and your accountant. Your accountant is not just there for your annual returns. They are a source of business expertise, and businesses should be willing to pay for this professional advice. No business will experience an issue their accountant will not have not come across before.”

As inflation rises, SMEs are also likely to see an increase in the number of employees seeking pay increases, McDonnell added.

“Anticipate those conversations, if they haven’t occurred already,” he said. “Any conversation about wages is a good time to address efficiency and productivity – is there more your business could be doing to operate more efficiently, for example, thereby mitigating inbound cost increases?”