Matthew Wild

Written by: Matthew Wild and Ian Briant

Matthew Wild

Partner

Overcoming profitability problems in the residential care home sector

The care sector continues to present both opportunities and challenges for lenders.  We discuss common issues we faced in the residential care sector over a series of three articles.

In this article, we focus on profitability, ownership structures and value in distressed situations.

General profitability issues

Revenues remain under pressure as cash-strapped local authorities squeeze the fees they are prepared to pay residential homes for service users, passing on funding cuts from central Government. The high fixed cost base of most homes means that any fall in revenue, whether as a result of falling fees, or occupancy levels, will have a significant bottom line and cash-flow impact.

At the same time that revenues are under pressure, costs are continuing to rise.

Employment costs are rising as a result of the following:

  • further increases in the living wage are expected and an hourly rate of £9 is likely by 2021; and
  • auto-enrolment now applies to all operators with minimum employers’ contributions now set at 3 per cent of qualifying earnings.

We estimate that these changes have increased average employment costs per employee by over 10 per cent over the past two years. Future increases in the national minimum wage will further increase the salary cost for operators.

In addition to this, energy bills have steadily increased year-on-year and whilst there are political moves to increase regulation and limit future energy costs paid by consumers, it is currently unclear if this will assist customers.  

Ownership structures

We frequently come across owner-managed businesses held within complex group structures and unclear ownership arrangements (a mixture of partnerships, sole traderships, limited liability partnerships and companies). In most cases, these structures have arisen following expansion and acquisition and a lack corporate planning on the part of the owner or professional advice. 

These complex group and ownership structures can cause problems when restructuring is necessary:

  • refinancing existing lending can prove challenging as complex group structures and ownership arrangements are likely to be unappealing to potential lenders; and
  • enforcing security can prove challenging, particularly in where group structures have assets held in personal or partnership accounts. In such cases, enforcement via LPA receivership is the preferred route. This can often limit options and incur additional costs of realisation.

Value in distressed situations

Operators in financial distress typically don’t have surplus cash to invest in the fabric or operation of their care home(s) which can often result in adverse Care Quality Commission (CQC) ratings. This can lead to a downward spiral ultimately resulting in cash shortages. As the financial distress becomes more acute, the options available tend to become more limited.

Whilst insolvencies are less common, and managed disposals outside insolvency are generally preferable, failures are sometimes unavoidable and can lead to a period of trading (generally in administration) whilst the business can be marketed, sold and transferred to an alternative operator.  As always, trading insolvencies are costly and where a new operator acquires the business some time may be needed to allow the CQC to approve registration of the new operator.

Summary

The sector remains an attractive one to investors and continues to provide opportunities given positive demographic trends, however, regulatory compliance is vital and a strong, focussed management team will be better placed to deliver positive returns in what remains a challenging sector.

Lenders should monitor operators closely and act quickly in the event of either a downturn in either financial performance or regulatory compliance to keep options open and protect security value.

For more information, please contact one of our restructuring advisory experts. 

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