Why are companies choosing to enter administration and how effective is it in helping businesses survive?

March 2023 saw the highest number of companies entering into administration, with a total of 2,457 business insolvencies recorded in England and Wales, according to a new report by Business Rescue Report. Matt Dalton, consumer sector lead, explains why companies are choosing to enter administration and how effective is administration in helping businesses survive.

This article was written by Cynera Rodricks and first published on Retail Sector.

Can you tell me about yourself?

I am a chartered accountant and I lead the expanding retail and consumer goods sector, responsible for defining and implementing the Mazars strategy for our consumer clients. I’m also a consulting partner that brings insight and value to clients by directing our full suite of integrated services including digital strategy, cyber, internal audit, M&A, forensics, tax and insolvencies. I work with many global consumer brands.

Prior to Mazars, I spent 17 years at EY working across EMEA in a senior risk transformation role with international clients.

March 2023 saw the highest numbers of companies entering into administration since March 2020, is it the culmination of Covid closely followed by the cost of living crisis?

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The administration (and insolvency) figures have been rising steadily in recent months, due to government intervention preventing a large number of businesses from entering an insolvency process.

Covid-19 and the ongoing cost of living crisis have caused the market to disrupt, and dampened consumer confidence and spending, which the discretionary spend market heavily relies on. The aftermath of the two has left businesses with large and unsustainable legacy debts which cannot be serviced or repaid in the near to medium term, as revenue and profitability recovery curves get pushed further and further out.

However, the factors affecting businesses in stress and distress are wider than this. Russia’s invasion of Ukraine has deeply unsettled the global economy, leading to spiralling inflation and soaring energy bills. In the UK, in particular, strikes by unions in key public services such as teaching, health and transport are adding pressure, as staff struggle to get to work and customers prioritise needs, rather than spending on retail and dining destinations.

A weak economic outlook, undermined by inflation at 40-year highs and interest rates at levels not seen for over a decade, make it clear why more and more companies are starting to feel the burden of these headwinds, making directors question whether their businesses will survive.

In your opinion why are companies choosing to enter administration rather than considering other options such as seeking outside investment?

Administration is always an option amongst a host of other options a well-advised board should consider. These options include new debt or equity investment, considering non-core asset disposals, cost reduction programmes, moth-balling loss-making operations and existing non-strategic markets.

Businesses with strong underlying operating models or those who activate in growth markets (such as technology, ecommerce, health, food and drink manufacturing and so on) are, in most cases, going to be able to access debt or equity capital markets to find support from existing stakeholders and/or external investment.

However, consumer retail has been a sector in transition for some time. The last 10 years have seen the disappearance of analogue consumerism, fuelled by the rapid transition to online shopping, the growing importance of consumer experiences and heightened consumer expectations. The power dynamic has therefore shifted from the retailer to the consumer, and this digital disruption will only gain momentum in the next ten years. The implications on the sector have therefore been profound.

Taking the above into consideration, in a number of cases, solvent options can be limited for businesses struggling in the consumer sector. For such businesses, an insolvency (which should be noted is often used as a mechanism to save at least part of the business as a going concern) can be the only realistic option.

Christina Fitzgerald, president of R3, the insolvency and restructuring trade body said: ‘The rise in corporate insolvencies have been driven by increasing numbers of Creditors Voluntary Liquidations (CVLs)’. Do you agree?

The statistics published by the UK Insolvency Service are clear. CVLs have increased from around 600 per month at the turn of 2021 up to a peak of 2,000 in March 2023. This is clearly driving the overall insolvency figures for this period as businesses at the smaller end of the spectrum (often with fewer assets on the balance sheet) face no other option other than to enter into a CVL process.

How effective are administrations in helping businesses to survive in the long term?

Administrations can be effective tools for businesses if used correctly. In the short term an administration process brings protection to the business from adverse creditor action and in the longer term allows the stronger, more valuable and profitable parts of the business to be sold and therefore continue either as a standalone entity (in the case of a private or financial purchaser) or as part of a larger corporate group (in the case of a trade purchaser).

There is never any guarantee that a business which enters administration once, may not suffer financial difficulties at a later stage. However, if the restructuring or sale out of administration has been structured in a sensible and orderly fashion, this should reduce the chances of this happening.

How does administration impact operations and employees?

An administration process can have wide ranging impacts on the ongoing operations of a business and its employees. In terms of operations, the board of directors lose their powers to control and administer the business all of which pass onto the appointed insolvency practitioners. Secondly, key contractual agreements the business has with both customers and suppliers can potentially be disrupted and/or terminated at the point of insolvency which is something which needs to be managed ahead of time.

The first 14 days in the administration period are crucial for employees, given that redundancies can occur in many situations. However, if the company survives (though some form of sale process) it is possible that some/all jobs can be saved. If administrators fail to turn the business around within an acceptable time frame, the company will inevitably face liquidation.

For employees, liquidation also means termination of employment. It’s a harsh but unfortunately all too common reality of the economy, particularly in difficult times. If this happens, employees will be made redundant.

In your opinion is it an ethical practice?

Yes, when used in the right way and in the right circumstances, and when stakeholders are appropriately advised by both financial and legal experts in restructuring and insolvency, administration is an ethical practice.

Do you anticipate an increase in administrations in the next 1-2 years?

This is difficult to tell with any certainty. However, in the coming 1-2 years, I predict that we will start to see this distress (and therefore insolvency appointments) percolate up into the upper Midmarket and larger corporate space. This may not necessarily result in more administrations overall but could result in a change in the mix of which market segment sees these appointments taking place.

What trends/ changes do you anticipate in the next 5 years?

From a personal point of view, I anticipate that as markets stabilise, and various macro-economic factors (e.g. inflation, interest rates, GDP growth and so on) return to the longer term trend, we will see a higher prevalence of solvent solutions and company turnaround strategies come to the fore. The return to more active debt and equity markets will also give more options to businesses in distress and may help avert, in some situations, an insolvency solution being sought.

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