What impact would a UK downturn have on the workforce solutions sector?

Eight lessons from previous recessions

It does not take a professional economist to predict that a serious economic downturn is possible in the UK. Given that workforces will be impacted by this, many companies providing workforce support services are likely to be particularly affected.

One thing that may be different about any new downturn is the extent to which, for the time being, there is still relatively full employment in terms of those said to be looking for work in many areas. This may act as a buffer for staffing and recruitment businesses, especially those involved in areas of labour and skills shortages such as in healthcare and IT and, perhaps, climate change-related roles.

But most businesses will be affected to a greater or lesser extent, and the history of previous downturns since the early 1990s help shed light on what may happen to UK staffing, recruitment, consultancy, payroll and training companies and tech-enabled workforce solutions companies, like gig worker platforms. These, assuming there is indeed a significant downturn, are some of our predictions.

Will there be fire sales and insolvencies? 

Staffing companies tend, given their cashflow cycle, to throw off cash as volumes decline – and that can give them time to adjust their cost base. Historically, most costs for these companies have been people costs, including commission arrangements (with relatively little fixed cost), which has generally helped them trade through. And, of course, in many ways staffing, which involves providing staff on a "no long-term commitment" basis to end clients, can be more attractive than having large permanent workforces and relatively counter-cyclical. So, staffing companies generally tend to be resilient in downturns.

However, the rising cost of cashflow funding via invoice discounting and factoring may increase costs for some. Staffing and recruitment companies that have significant client concentration and any serious bad debt within that client group – or whose key clients set up managed service provider (MSP) arrangements targeting margin or rate reduction – are likely to face a difficult time, as has happened in the past.

In previous recessions, fire sales have been relatively hard to engineer in the sector. This is, in a large part, because people are the main asset of most traditional staffing and recruitment businesses, and what has historically tended to happen, before any fire sale can be completed, is that the key staff "walk" taking all value with them, or contractors and clients get wind of business's problems leaving the victim company with little value to transfer to a fire-sale acquiror.

The lesson here is (obviously) to avoid excessive client concentration and keep an eye on slow payers, and, in the case of MPSs, take action if there are any signs that the MSP client might go under. Pay attention to alerts issued by credit insurers. Be ready to take very quick action if bad debts or the like seem likely to cause problems – in this sector if shareholders, or opportunistic buyers, let things drag they can be left with little value very quickly.

New types of opportunistic buyers?

In previous downturns there have, notwithstanding the above, been some successful opportunistic rescue arrangements. These will probably work best in situations where the target has institutionalised clients and has framework appointments which can transfer to a new owner. There is always a degree of risk in these situations and so investors will want to build in risk mitigation including earn out. 

In addition, if the worst comes to the worst, the good news for affected companies is that there may be overseas and tech investors more interested than in previous downturns in (currency-cheap) UK assets in the workforce solutions space. There are signs of overseas investors taking interest in the UK at the moment, and we are also already seeing tech companies take an interest in buying staffing, recruitment and payroll business into which they will then deploy their new automated systems.

MSP and automation will become more prevalent

MSP and recruitment process outsourcing (RPO) arrangements started in the UK in the early 1990s, on the back of the 1990-1992 recession, as a way to help reduce end-client costs by targeting staffing and recruitment companies that were deemed to have excessive margins. We suspect that this traditional aspect of MSP and RPO usage will return in many subsectors combined with an accelerated focus (supported by MSP/RPO or HR tech companies) on direct attraction and internal recruitment or staff-bank arrangements, using technology to automate processes. End users' growing awareness and concerns about staffing supply-chain risk is also likely to lead to increased outsourcing of compliance and risk to MSP and RPO suppliers. 

Migration of existing supplier arrangements will inevitably follow. This will, as in previous downturns, lead to an element of forced migration of contractors to cheaper arrangements. There are ways this can be legitimately done, but forced migrations often expose those involved to legal risk (including tax and employment status risk, and data protection breaches) and, in many cases can and should be avoided (or if you are adversely affected, prevented). Make sure, if you are a supplier, that your restrictions and temp-to-temp terms are enforceable: in some situations, it can be a criminal offence to try to charge a temp-to-temp fee where relevant contract terms do not permit that.

Workforce solutions companies with automated systems and perhaps an ability to offer staff-bank or rota management systems to clients on a software-as-a-service basis or tech companies that buy workforce solutions company assets may win larger market shares, especially in more volume-based areas of staffing and recruitment. This digital transformation is already a trend, but any downturn may accelerate it.  

And some new players in the MSP and RPO market do not always have systems that work: any supplier who finds themselves having to supply into or via new automated systems should ensure that time recording, and approval systems work and that they're not left having to fund payments to workers where the new systems fail. When agreeing transition to new arrangements, it would be prudent to reserve a right to revert to a manual or alternative system if time-recording or client-approval systems don't work as intended. 

Teams will move

Team moves can, of course, be a good thing for recruiters if they are the agents managing the team move.

But for those workforce solutions businesses who face losing their own key staff they are an obvious problem. In previous downturns, successful commission-based sales personnel have not hung around when volumes fall – for some it's the trigger to do what they and their closest colleagues have been thinking about for a few years, especially once the first signs of economic recovery appear. LinkedIn and other systems can make it easy for a recruiter to get started, and use of umbrella companies and the like to deal with payroll can make a business start-up seem easy. And so, it is inevitable that there will be a surge in team moves and start-ups in the next couple of years.

Tailored restrictive covenants, potential criminal breach of the Conduct Regulations, and data protection compliance can make it harder for these young stars to take business with them when they do go. So, this is traditionally a good moment to check you are up to date in those areas and to make clear who owns contacts made via social media so that you can deter the most damaging types of departure. 

Good time to look at share schemes?

If revenues are taking a hit but a company needs to hold on to key staff, many types of remuneration scheme can cease to be attractive or affordable. But this can be a good time to tie key staff in with a new share scheme, with HMRC being relatively likely to accept low starting-point valuations of shares. 

Setting up these schemes at the same time as introducing updated restrictive covenants will increase the enforceability of those covenants and help secure corporate value for the future.

Dodgy tax schemes risk serious liability

They may become very alluring again, but dodgy tax schemes may expose hirers, staffing companies and directors personally to serious liability. When margins become tight, the temptation to find extra profit by allowing workers to be engaged via schemes which avoid or evade tax and National Insurance Contributions becomes more attractive, especially where competitors are using or knowingly turning a blind eye to the use of such schemes in their supply chains. This seems to happen every time there is new pressure on margins and pay rates in the UK, from the 1970's growth in gross off-payroll payments to agency workers (leading to the Agencies Legislation in the original version of chapter 7 part 2 of the Income Tax (Earnings and Pensions) Act ITEPA) and onwards.

History suggests that the government's decision not to undo the current IR35 regime, closing for many the personal service company route to higher take home pay, is likely to increase the attractiveness of aggressive tax avoidance and tax evasion arrangements including via some, but not all, umbrella companies.

Our previous Insights, "Regimes other than IR35 which HMRC can use against tax schemes" and "IR35 stays", explain some of the perils of using these arrangements in your supply chain. The key things to remember, by comparison with previous eras, is that HMRC has much more effective anti-avoidance weapons now and, as a result of the intermediaries reporting regulations, data about payment flows. And it seems likely that the new prime minister will feel the need to collect tax where possible.  

We are already seeing HMRC use the managed service company legislation (chapter 9 of part 2 of ITEPA), the "enabling tax avoidance" legislation of 2017 and the Criminal Finances Act 2017 to attack all in the supply chain involved in relevant arrangements. In some cases, this may involve personal liability for directors of companies along the supply chain and it's likely that we'll start to see increased enforcement of the new IR35 in the private sector within the next couple of years. Turning a blind eye to or allowing these schemes to be used is often prompted by a wish to remain competitive, but these days no one should assume that HMRC will not spot what is happening and take action against anyone in the supply chain they deem culpable. 

Take extreme care and make sure you have in place all necessary checking procedures to evidence how and how much workers are paid. Reliance on self-certification, accreditation checks by trade associations and contractual indemnities will provide no real protection against the potentially significant HMRC claims that may be made in coming years. We expect larger end users to be more alive to what is going on in their supply chains than in previous eras, leading, potentially, to growth in the market share of staffing companies and MSPs (and compliant umbrella and employer-of-record companies) who can demonstrate that they are on top of this sort of risk.

Going 'global lite'

We're likely to see companies look to hedge UK economic risk by focussing even more on providing services overseas or for overseas clients. But setting up international offices can be expensive, which is probably not an attractive thought for companies suffering in a downturn.

Many systems have been developed in recent years to facilitate the wish of workforce solutions companies to go "global lite" and we expect this trend to continue with all sorts of virtual international offices and the like, including a growing use of employer-of record arrangements. It's essential to pick the right partners in this process – many virtual arrangements we see are in fact unlawful and many local partners do not operate compliantly. It's important to understand exactly how these players operate and carry out proper in-country due diligence if they are to add value rather than longer-term liability and cost.

What about hire-train-deploy models?

Traditionally, training is one of the first things many organisations have cut in downturns, and we suspect the same will happen this time, except in areas of severe skills shortages and where government subsidies are available for (re-)training people who lose their jobs in the coming months.

Where will this leave the companies that have set up hire-train-deploy models in recent years? Probably they will continue to do well in areas where there are still serious skills shortages and not so well otherwise, with some well-known players in this space already being less successful than in previous years.

Osborne Clarke comment

Clearly the next year or so may be challenging for companies in the workforce solutions sector, but in previous downturns we have seen most companies adapt and trade through and in many cases do very well by exploiting the opportunities that this time of change will bring. And it's likely there will new types of opportunistic investor.

What may be particularly different to previous eras is the acceleration in the use of technology to transform processes and the awareness that the use of dodgy tax schemes to help preserve profits or market share is much more dangerous for all in the supply chain than in previous years, both of which factors may lead to more sophisticated suppliers increasing market share. Given also the likelihood of many new entrants and start-ups in the sector as always happens after a downturn, many smaller and mid-size companies that do not have a healthy niche may come under particular pressure.