How can firms restructure responsibly? In the COVID-19 era, many boards and senior executives have made enormous decisions about the short-term changes they need to make to their business to stay alive. Many have acted with integrity and considered their entire group of stakeholders, not just shareholders, and done the right thing for their customers and employees. Others have reverted to the crisis playbooks of yesteryear.
Just a few months ago, in January 2020, the rise of ESG investing reached a crescendo at the World Economic Forum in Davos, Switzerland. The global elite spoke lovingly about their sustainability initiatives and measures they were taking to reduce ESG risk inside their firms. Institutional investors, riding high on a decade long asset price rise, were very comfortable with the new direction.
Where are many of these voices now? The environmental, social and governance risks for firms emerging from the response to the COVID-19 health crisis are enormous. Because of the advice around social distancing, use of personal protective equipment, and working from home wherever possible, there are obvious worker health and safety risks. Some firms have responded well, others have acted as if the last 50 years didn’t happen.
The social risks from continuing to insist on retail tenants trading when there is already low foot traffic in shopping malls, for example, will be held to account once this is over. The inability of a firm to hibernate in a competitive and contract-driven world should have been clearer to policymakers. However, the speed of the response has led to grave policy errors that will extend the hurt throughout the economy and risk social problems because of the prioritisation of larger firms over small business and workers.
Restructuring your operations responsibly in a crisis can be done. It means working closely with all stakeholders wherever possible, and not making unilateral decisions without open communication and at least an attempt at consultation or engagement. The “panic stations” approach taken by some during this crisis has highlighted how everything they wrote in the front matter of their most recent annual report was complete nonsense.
What has been good to see is some firms choosing to draw down credit lines and leverage the support the banks are getting from central banks to tap their banking syndicate before doing highly dilutive equity raising in a time of high uncertainty. For firms that have a decent chance of doing well on the other side of the bridge, the extra medium-term debt in their capital structure is probably a better bet than an equity raise.
For small businesses, restructuring responsibly in a situation like COVID-19 can be almost impossible. To have the flexibility to do a responsible restructure, you already needed a strong balance sheet and decent cash flow history. Your banker will be aware of government guarantees, but you still need to be a good credit.
Many of the businesses most impacted by the collapse in sales simply were never and will never be good credits. Low margin, high volume businesses will only be good credits if they have some sort of collateral like owning the restaurant building or a distribution warehouse with a low loan-to-value ratio.
Completely independent of what policymakers may think, the banks still have their internal business rules around risk. Even though there has been some easing of regulation, that doesn’t mean the banks will suddenly make enormous amounts of credit available. The bank CEOs have been clear about this – they will eventually be picking winners and losers. Banks have the best transaction and risk data to consider whether the business they’re considering extending credit to will be able to make a good go of it on the other side of this pandemic.
An example of the difficult position small businesses find themselves in is that three main areas of risk – payroll, lease obligations and trade creditors – can’t all just be put on pause without consequences. A move towards cash on delivery and repayment of any deferred lease liability could mean that more businesses are untenable because of the higher working capital requirement alone.
This situation means that responsible restructuring will only be feasible for the strongest SMEs. They will need to innovate by creating new product and service lines that comply with changing consumer preferences. Their payroll will need to reflect the new normal, and if that means layoffs, paying out full entitlements or claiming wage subsidies to help employees through this is the right thing to do.
The rapid decision-making in a crisis can sometimes stop the risk of going out of business, but there are lasting consequences to any mistakes made during the process. Of particular concern are the audit and assurance risks around many of the decisions made. There will be an accounting for errors made by firms. In essence, banks will closely monitor the use of funds obtained by credit, governments will audit subsidies, employment regulators will audit layoffs, and tax offices will review tax returns and reimbursements.
The consequence of an irresponsible attitude towards restructuring during this crisis is that many businesses will not be able to reopen on the other side of the bridge. This scenario is different from the economic reality. In essence, some firms are simply not viable, and their directors have closed doors because that is the right thing to do in their particular situation.
Where I see a lot of risks is that because so many people have been negatively affected by this economic crisis, there will be a lot of judgement and community expectations around what “the right thing to do” really was during COVID-19. ESG risks must still be identified and managed appropriately during this crisis, just like the rule of law isn’t on hold. Boards and senior executives should consider how they’ve approached their response so far. If you can improve outcomes for stakeholders before the crisis is over, make an in-flight adjustment now. It’s better to alleviate pain than be the subject of investigative reporting or regulatory consequences once this is over.