The Easter Bank Holiday has been and gone, and with it a sense that the UK has navigated Phase 1 of COVID-19. The initial panic and dash-for-cash experienced in the first weeks of lockdown is abating to some degree. Lenders alongside the Government have continued to work through Phase 2 to bring to life promised support and funding for the many companies still facing huge financial stress from nullified revenues. As we all undergo the second round of lockdown, it is key to remain vigilant in the face of new challenges as we continue to navigate COVID-19. We do so now in the knowledge that potential economic and social norms will remain a mystery kept for a post-COVID world, the ‘new normal’.
In parts 1, 2 and 3 we provided an overview on the current COVID-impacted situation as it developed and the business and finance trends our portfolio companies were experiencing. In this article we move from the pragmatic to the theoretical as we look to the future to understand the extent of which nothing will be the same, and how best to prepare for this.
Part four – Expect the unexpected
Consumer reaction
We cannot expect the same consumer behaviours coming out of COVID-19 compared to previous periods of economic stress. This is because the situation and expectations are different, despite the overall scenario, the likely recession, being the same.
Downturns are typically created by negative shocks in either supply or demand. One trigger for the Great Depression of the 1930’s was the over-supply of product in the UK, and lack of sufficient demand therefore generating a ‘demand shock’. In the Great Recession of the noughties, the ability to supply liquidity as banks and lenders suffered a Credit Crunch created a ‘supply shock’.
COVID-19 is a never before experienced legislated recession and is expected to create a ‘double impact’ with enforced lockdown creating something systemically similar to ‘demand shock’, which will potentially turn to ‘supply shock’ when the world re-opens for trading. This will create a jagged recovery in which the governmental cash injections already seen are supported by quantitative easing further down the line to re-stoke the economy back to life. The aggressive, COVID-impacted growth ‘V’ curve the economy was originally anticipated to experience is increasingly looking more like a ‘U’ curve at best, but possibly an ‘L’ curve. It is unlikely that some industries that have been put to sleep can simply wake up again, or they will need to look very different to do so.
One constant in each downturn we have faced is the spike in unemployment rates. This usually creates further recessionary features through declining consumer confidence. In the case of this COVID-19 downturn, unemployment continues to grow with the UK experiencing a 5 year high and 22 million in the US reportedly losing their jobs as at 21 April 2020. The hope has been that this unique unemployment would be short-term, and we would witness a rapid return to work once the economy kicked into gear and lockdown restrictions were lifted.
This would be a positive lever for economic recovery and with employees either furloughed or working from home with diminished monthly costs, there is a chance of a significant jump in consumer spending once we are released from lockdown. However, businesses and consumers are no longer expecting lockdown restrictions to simply be lifted. At the very least, we are likely looking at lockdown becoming a phased process with varying grades of severity lasting at a minimum for the rest of the summer, but more likely until treatments or a vaccine are developed. This is another cause for the jagged recovery and the outcome is a more cautious and therefore more frugal consumer base with their focus on savings to shore up personal balance sheets.
With the period ahead looking increasingly unclear, businesses should not expect to rely on the same consumer behaviours that they had prior to COVID-19. Significant thought should go into the end-user and how COVID-19 may have impacted their spending habits to ensure product / service positioning is still optimally placed and, in some cases, still relevant. For example, how does a bar or restaurant with social distancing measures and a reduced menu offering (to minimise staff costs and stock levels) provide an experience that still attracts the consumer? Or how do airlines and hotels provide assurance that their products are safe for consumers to commit to? These are the types of questions that will likely shift from pre-COVID triviality to post COVID pertinency as part of the ‘new normal’.
Investor reaction
The COVID related impact felt across international stock markets, private M&A, fundraising and debt raising processes has been considerable. One of the issues we are seeing is in due diligence. In particular, the ability for financial due diligence (“FDD”) providers to give assurance on a set of forecasts given the risk of being held liable should the information prove to be materially incorrect. Naturally, given current uncertainty, there are few situations where FDD advisers can provide reliance on even medium-term forecasts. Without FDD assurance, banks are unable to agree new debt issuances. Similarly, how does management warrant their forecasts? This will no doubt be addressed by the innovative and rapidly growing (at least until recently) W&I market to ensure that neither management or the buyer have incorrect exposure.
Therefore, acquisitions (and wider growth initiatives) must be funded by equity, having a knock-on effect on returns generated. The domino effect this may well have is a wide-spread decrease in multiples paid. Even businesses that trade positively through COVID-19 should not expect the same multiple landscape as they may have seen pre-COVID.
These issues could have a negative impact on accessibility to assets as owners weigh up whether it is worth coming to market for an impacted return. However, it is important to consider the wider expected and unexpected impacts of the pandemic. The financial stimulus packages provided by the government to date will need to be recouped in the future through various taxation measures. There is a high likelihood that this will be seen through further changes to Entrepreneurs Relief (“ER”), and changes to Capital Gains Taxation (“CGT”). It may be that the personal tax impact on a sale further in the future nets out the gains made in EBITDA growth or multiple improvements. Another important factor in making this decision will be considering the unknown operational risks and demands of navigating a business through a recovery period; the length of which we do not yet know.
The role of technology
We have heard more than once the question being asked as to how the world would have managed COVID-19 even a decade ago. The answer is very differently, with the likelihood of a significantly more negative outcome without the use of technology as the enabler of operating day to day business.
Businesses utilising technology to their advantage have found they are better able to absorb the shock of the current situation and will be better placed to grow in a post COVID world. One example of this we have witnessed is the speed in which doctors have embraced video consults when previously there has been profound resistance. We have found these to be very effective at our portfolio company The Dermatology Partnership. The business has pivoted to offering all consultations online, with subsequent procedures scheduled suitably into the future and kept flexible to take into account the uncertain nature of the lockdown.
Our rapidly growing buy and build Cloud Managed Service Provider (“MSP”), Air IT, experienced Service Desk tickets surge 300% during Phase 1 of lockdown as businesses adapted to working remotely. For these businesses that had adopted Cloud technology, it is playing a leading role in their ability to cope through COVID-19. However, it is not those who are yet to adopt that are being hit hardest, it is those caught in the middle. Decisions during this period are being undertaken on a time-to-value and cash-to-complete basis, as opposed to being driven by Return on Invested Capital (“ROIC”) as seen pre-COVID.
Whilst technology has been essential for business during lockdown, it also has its vulnerabilities. Companies have experienced a surge in cyber-attacks with varying degrees of severity as hackers take advantage of the increase in access points caused by remote working. Some businesses have noted a decrease in productivity due to outdated or ill-equipped laptops that are being ‘sweated’ as part of a spending freeze.
Furthermore, COVID-19 may be the final straw for entire sectors that have been fighting a losing battle with technology, such as high-street retail. Technology will continue to evolve even during economic downturn. Ensuring your business is in a position to capitalise on this when we return to growth will provide essential support in navigating any unexpected post-COVID shocks as well as benefit from growth opportunities.
Conclusion
Throughout this COVID-impacted period, our portfolio businesses have shown their mettle through their rapid response, ability to pivot and consistent positive attitudes. We have shared a vast amount of information together over the period and one assured positive is that, despite being more remote than ever, this period has brought us closer together. Whilst COVID-19 and its impacts are far from over, a lot of our businesses are now turning to the future and thinking, with our assistance, about how to best position themselves for growth. Expecting the unexpected will be one of the largest challenges for our portfolio businesses and all SME’s as the shoreline of a post-COVID world begins to form on the horizon.
