Most countries in the world have been heavily affected by COVID-19 since the beginning of the crisis last year. The United Nations Secretary-General António Guterres rightly described the pandemic as the worst global crisis facing humanity since the Second World War. After first emerging in China the spread of the virus pushed many countries to impose national lockdowns and quarantine policies to flatten the exponential growth curve of infections. As a result, global economies have faced unprecedented decline and many companies have been forced to cease their activities, leading to operational or liquidity crises.
Small and medium-size enterprises are the lifeblood of the UK economy. They account for 50 percent of the total revenue generated by UK businesses and 44 percent of the country’s labour force.[1] However, in times of crisis, small and medium-sized enterprises (SMEs) are usually the most affected because they have fewer resources and a relatively high failure rate[1]. Bearing this in mind, governments around the world have put in place measures to support SMEs’ cashflow and try to prevent them from going bankrupt. In the UK, the Federation of Small Businesses (FSB) warned that in the absence of solid support, 250,000 SMEs were on the way to bankruptcy as a result of COVID-19 and the government put in place a series of financial measures to support SMEs[2]. On top of the £4.6bn support plan intended for the hardest-hit companies announced in early 2021, Chancellor of the Exchequer Rishi Sunak has promised £520m to spur SMEs innovation and boost their productivity in his new budget on 3 March. Indeed, in productivity (output per hour worked) the UK has a deficit of 16 percent when compared with other G7 members, and of more than 20 percent when compared with US and Germany. These measures could help close Britain’s productivity gap with rival nations. But what other solutions are there to support SMEs’ cashflow in times of crisis and avoid defaults?
Can leaseback be a lifeline?
The global financial crisis has revealed the importance of liquidity for companies. Facing cashflow constraints, companies are postponing repayments to lenders, which in turn aggravates their situation by making it more difficult to obtain credit in the future. Faced to such a situation, the use of disintermediated financing tools such as leaseback could be a real financing lever.
Leaseback, also called sale-leaseback, could be a solution for business managers to overcome their cashflow difficulties, particularly in challenging times of crisis when credit offers from bank are restricted. Leaseback is an arbitrage transaction on property assets. The company sells one or more property assets to a leasing company and then leases them back for a specific period under specific terms. The company then maintains the use of the transferred asset and receives cash. It is a long-term contract with a buy-back option allowing the company to regain ownership of its assets in return for the payment of a price fixed in the contract.
This para-banking technique allows the company to generate immediate cashflow, but it is not a way of financing to meet a structural cash position. Leaseback is for businesses with cashflow difficulties due to special circumstances, notably in times of crisis. Leaseback is also best suited to companies that are financially sound but have sudden liquidity problems, since leasing companies will consider the overall financial situation of the company before going ahead with a leaseback contract.
Advantages and disadvantages
Compared to owning assets, leaseback has several advantages. It allows the company to generate cashflow and to benefit from tax breaks since leasing fees are deductible expenses. However, there are disadvantages too. A company that chooses to leaseback will have fewer assets, and it will reduce its debt capacity. This is because fixed assets are the collateral usually required by banks and are an important measure of the company’s solvency.
Moreover, SME owners and directors need to be careful about the destination of the cash generated by the leaseback operation. Using this cash solely to reduce balance sheet debt only postpones cashflow problems. A better strategy is to use the cash generated to finance new investment and generate added value that can be quickly converted into cash.
SMEs are a vital part of the economy. They are key drivers for growth, innovation, and employment. Unfortunately, they are more likely to be financially constrained than large companies, and this makes them particularly vulnerable in times of crisis and downturn. Leaseback could be a plausible solution for many struggling SMEs looking for financing. It could represent a lifeline which could save many SMEs from insolvency and ultimate closure.
[1] UK Department for Business, Energy & Industrial Strategy, gov.uk.
[2] https://voxeu.org/article/support-small-businesses-amid-covid-19
[3] https://www.instituteforgovernment.org.uk/explainers/coronavirus-support-businesses-first-lockdown
Exclusive to SME Today. By Professor Ramzi BEN KRAIEM, Audencia, Souad BRINETTE, Associated Professor, EDC Paris Business School, and Sabrina KHEMIRI, Lecturer, Paris-Saclay University