Three ways swapping debt for equity can aid the UK’s economic recovery

25 February 2021

With Chancellor Rishi Sunak due to deliver his Budget next week, the future of many indebted businesses hangs in the balance. Our Policy Lead Will Thomson shares some possible bold interventions in line with the ambition we want to see next week.

As we edge closer to spring and the vaccine programme continues at pace, it feels that we may have reached a turning point with the pandemic. The Government has published its ‘irreversible’ roadmap out of lockdown and perhaps we can cautiously hope that the worst might be behind us. It is timely, then, that the Chancellor will deliver his Budget next week to set out how the Government will continue to support people and businesses through the long Covid recovery.

Without dispelling too much optimism, there are some serious economic challenges on the horizon. The UK may have narrowly avoided a double dip recession last quarter, but the long and protracted lockdowns have hit businesses hard. Many have taken on significant levels of debt to stay afloat – in part through government guaranteed lending schemes, as well as rent holidays and other commercial loans.

This mounting debt presents a problem: high levels of corporate indebtedness are likely to prolong any economic downturn precipitated by the pandemic. The Recapitalisation Group estimate that the total unsustainable business debt by March 2021 will be £67-£70bn, with as much as £20-£23bn of that expected to stem from government-guaranteed lending schemes – SMEs were estimated to incur about half of this unsustainable debt. According to the FSB, two thirds of SMEs expect their performance to worsen in the near future. 34% of SMEs have increased their levels of debt, with 40% now saying that they are carrying ‘unmanageable debt’ (up from 13% pre-Covid).

There is also an important place-dimension to this: much of the unsustainable debt is held in UK regions outside of London, which is exacerbated by regional disparities in SME access to equity finance. Regions outside of London account for 72% of unsustainable debt, but only account for 25% of SME equity finance – with availability of equity finance heavily skewed towards London and the South East.

Further pressures are emerging, including the need to repay VAT and other deferred taxes, loan repayments, and the reintroduction of business rates; not to mention the substantial unsettled rent debt from Covid crisis period – especially for hospitality, estimated at £1.6bn.

Even for businesses that do manage to stay afloat, there is a danger of creating a new generation of ‘zombie companies’ that are locked in a cycle of generating cash to service their debt load and are not able to make a material contribution to a growing economy. It is therefore essential that we tackle this issue head on to ensure that viable businesses are not saddled with unmanageable levels of debt that would cripple the SME sector – vital to a healthy market economy – and endanger jobs and livelihoods.

A variety of proposals have been mooted to ease the debt burden for smaller businesses – but there is potential for social investment to play a pivotal role in shaping the response to this issue. The scale of government-backed lending presents a rare opportunity to utilise debt-for-equity swaps that could considerably expand the social economy by transitioning at-risk, yet viable, private enterprises to employee or community ownership at scale.

This idea would see all CBILS and BBLS loans transferred to a separate fund or ‘holding company’ that would oversee and manage the unsustainable debt that is already government guaranteed. This fund would issue long-term, patient equity funding to indebted SMEs, taking full or partial ownership of the business, with a view to exit when economic conditions have stabilised. The holding company could be disaggregated into regional funds to ensure a place-focus is retained and equity finance is distributed to areas that are currently underserved.

The fund would have a remit to facilitate the transition of SMEs to more social business models, including employee ownership, hybrid-shared ownership, or asset-locked community businesses. One mechanism to achieve this would be to explore how Employee Ownership Trust structures could be adapted to CBILS and BBLS loans. Special financial incentives – including preferential tax breaks – could be introduced for owners who consider this employee buyout route from the fund.  

To ensure this is aligned with the levelling up agenda, there could be strategic criteria specific to location and/or sector – targeting areas of higher deprivation, particularly those with low job density and below average incomes (e.g. coastal areas, ex-industrial towns); or sectors that have experienced a profound disruption as a result of Covid (e.g. hospitality, retail).

This debt-for-equity idea has three key benefits that would support a more equitable economic recovery:

  1. Reducing the unmanageable debt burden of SMEs that have been impacted by the pandemic, which is likely to weigh down the economy during the recovery.
  2. Protecting local businesses and jobs and avoiding the dislocation and economic damage experienced by communities when significant local employers go into administration or collapse.
  3. Facilitating the transition of private businesses toward more social business models that have the potential to transform employment by paying higher wages, increasing workforce solidarity and providing a richer set of benefits to employees.

Building back better requires bold interventions that not only stabilise the economy, but tackle some of the root causes of inequality – low pay, job insecurity, and a lack of representation. Our response must therefore not simply focus on job retention, but on ensuring that people have access to good, secure jobs with decent pay and working conditions. This is the kind of ambition we want to see at the Budget next week.

A debt-for-equity fund on this scale could have a transformative impact on communities, by expanding the social economy at scale, stabilising businesses, and empowering the workforce. This is an opportunity to create a more inclusive economy – one that genuinely aligns with the core ambitions of the levelling up agenda by supporting local business, protecting jobs, improving living standards and ultimately creating fairer communities.

Photo by Dan Burton on Unsplash

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Will Thomson

Policy Lead

Will joined SIB as Policy Coordinator in May 2019, becoming Policy Lead in December 2019.

Before joining SIB, he was a consultant at a Bristol-based public affairs agency and provided secretariat support for two All-Party Parliamentary Groups. He has produced a series of policy reports on devolution for the Bristol Chamber of Commerce and also worked with two social investment organisations based in the West of England.

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