In follow up to ‘Solvency considerations for purposeful businesses – A coronavirus guide’, which looked at the regulatory landscape and potential rescue mechanisms, here we take a look at ways in which borrowers and lenders might adjust their terms in order to manage their investments and preserve their social impact objectives, during the crisis.
The world is reeling from shock as COVID-19 has spread at astonishing speed with far reaching social and economic impact. With the value of the UK social investment market estimated at over £3.5bn, the approach taken by social investors to defaulting social investments will have a profound impact on the charity and social enterprise sector.
A number of social lenders are signatories to a statement that they will do their best to help where investees need support or flexibility. This flexibility reflects the approach taken generally in the financial market. What is unique about the social investment market is the potential for investors to offer restructuring terms based upon both financial and social impact metrics.
Governmental support has been announced with the £100m Resilience and Recovery Loan Fund. However, even with governmental support, the fallout from COVID-19 will inevitably result in some distressed borrowers and financial restructuring in the social investment market.
With so many charities and social enterprises facing cashflow and funding issues, what are some of the key restructuring issues to consider at this time?
Communication is key
It is important to establish an early dialogue about potential issues likely to arise. Issues such as late or missed repayments, anticipated cashflow problems or additional need for working capital are likely to be high on the agenda for many borrowers, particularly those reliant on trading or fundraising income streams.
Early communication will allow for time to plan and collaborate to agree a flexible and supportive way forward.
In transactions involving multiple lenders and layers of debt, the syndicate will need to agree a common approach for restructuring. The lenders may have differing risk appetites (both financial and social impact) depending on the nature of their investment, their own investment criteria and the extent of any security. An Intercreditor Agreement or Deed of Priority will set out the priority of repayment in the event of a distressed scenario.
Lenders may request more regular or more detailed information from borrowers under the information covenants.
Potential approaches to restructuring
Charities and social enterprises will be trying to predict the financial impact of COVID-19 in the short to medium term, to assess their cashflow and working capital needs.
For some, the service delivery required to achieve the intended social impact may have been rendered impossible to carry out (remotely or otherwise). In other cases, the impact may still be achievable, but it may not be possible to measure any impacts due to governmental restrictions such as social distancing.
Where a social investment transaction has impact key performance indicators or a financial offset based on impact achieved, the simplest way for the parties to deal with this is by amending the investment documentation to extend its maturity so that the impact can be achieved once normal service delivery is resumed. It is likely to be difficult to predict with certainty when this may be, and so the parties may wish to include a long stop date and some key dates for interim review.
For some recipients of social investment, their priorities and service delivery may already have adapted to meet the needs of those left most vulnerable from the pandemic. This may include changes to the profile of beneficiaries or the type of social issue the intervention is designed to deal with. In these circumstances, the parties may wish to negotiate changes to the impact metrics, either by changing the definition of the key performance indicators or adding in additional ones which better reflect the nature of the adapted services. This can be achieved by a relatively simple amendment and restatement agreement or letter.
In a distressed scenario driven by short term cash flow issues, a potential way to restructure could involve social investors waiving or delaying some or all debt repayments provided that certain impact metrics have been met. The parties could potentially negotiate interest rates or principal repayment reductions linked to the level of impact achieved (a ratchet). If debt repayments are delayed or deferred, an appropriate threshold of financial performance could be introduced before any repayments fall due.
Of course, the approach and extent of flexibility in each case will depend on the transactional circumstances and facts. In addition, each Lender will have their own institutional risk tolerance, percentage of acceptable debt write offs across loan portfolios and may have their own repayment obligations and cash flow issues to consider.
Planning for a post-COVID-19 future
The long term social and economic effects of COVID-19 will render some impact metrics more difficult to achieve in a post-COVID-19 world. For example, interventions designed to increase employment will be much harder to achieve in the context of high levels of unemployment and a recession. Other issues such as domestic violence, poverty, mental health, social care and homelessness are likely to need greater interventions and support. The parties may need to amend documentation to agree periodic reviews of impact metrics after the pandemic has ceased.
In conclusion, the direct and indirect consequences of COVID-19 are impossible to predict with any certainty yet. However, it is critical that a flexible and collaborative approach to any restructuring keeps social impact as a key consideration of decision making, in order to ensure that the social investment market continues to fund and achieve much needed social impact in a post-COVID-19 world.
 Big Society Capital, 20 November 2019, https://bigsocietycapital.com/latest/for-third-year-in-a-row-uk-social-investment-market-grows-by-30-now-worth-over-35-billion/