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Eurozone chaos allied to UK economic weakness could hit firms’ ability to access the funding they need
The eurozone crisis is the dominant theme in almost all serious media. In the past four years the story has risen and fallen like the tide, but has never gone away. However, some serious commentators are warning that the fallout from the current phase could be as serious as in 2008.
This is not good news, and whatever happens to Greece, the markets have yet to turn their attention to Spain and other countries. No law firm can afford to ignore the potential consequences.
Meanwhile, many boards are thinking hard about how they position their firms to succeed in this competitive environment. This is right and proper, but there is a danger that insufficient attention is being paid to other risks that, should they become reality, have the potential to seriously affect firms’ ability to operate, invest and compete.
We have just heard that in the first quarter of this year UK GDP contracted even more than originally estimated. Continuing economic weakness and the threat of eurozone meltdown present a cocktail of related risks that leave many firms exposed, especially if they rely on borrowed money.
The first risk is economic. Intense competition and price pressure depresses profits and delays cash receipts. Debt reduction is difficult, especially when partners are pressing for full and timely payout of profits.
The second concerns clients. There is a significantly increased risk of client default. Firms that are heavily reliant on a few key clients could get caught out.
The danger is that a loss creates a huge hole in the balance sheet and undermines the bank’s faith in a firm’s financial credibility.
Refinancing is the most pressing risk. Banks themselves are exposed directly and/or indirectly to the eurozone crisis. Despite their best intentions lenders may be unable to continue to provide funding to the same extent or on the same terms as previously.
Remember also that banks’ view of the legal sector will become bearish if they experience significant losses - a distinct possibility.
Although many firms borrow conservatively, too many are heavily reliant on the availability of substantial overdraft funding, sometimes to the point where the overdraft looks like a loan.
Unfortunately, the goalposts have moved. A previously unremarkable borrowing requirement may now be a significant threat if the economy further declines, clients get into trouble or bank balance-sheets are severely impaired. In such circumstances it is usually the ones that need it most that are regarded as the least attractive.
Too many firms are borrowing too much, and/or failing to arrange (and pay for) enough committed funding to meet their needs. Ultimately, the danger is that the funding you need and expect is not available to you, or is even withdrawn.
The sensible firm will review these risks regularly and devise policies to ensure they are not overexposed. Even in difficult times it is possible to reduce debt and manage the borrowing profile. The risks are real.