Unveiling the hidden fault lines: how VAT exposes deeper financial vulnerabilities in private schools

Posted: 23/06/2025

VAT is not the cause – it is the catalyst 

The imposition of VAT on private school fees has put a number of schools under renewed financial pressure. Politically presented as a levelling measure between the state and private sectors, it has had a clear operational impact. But from a restructuring and insolvency perspective, VAT is not the root cause of distress – it is the trigger that is exposing long-standing industry fragilities.

Schools already operating on narrow margins, with declining enrolment and limited financial resilience, are now being pushed into crisis. The current wave of financial failures is the outcome of pre-existing vulnerabilities, not simply policy change.

A slow erosion of viability: recognising the pattern

Many schools that become insolvent can exhibit some of the same underlying characteristics:

• rising fixed costs (notably payroll, pensions, and estate maintenance) outpacing revenue growth;
• over-reliance on fee income, without diversified income streams (eg donations, letting, or investment income);
• discounting and bursary increases, reducing net fee intake while masking declining demand;
• governance that lacks financial forecasting discipline, with decisions often being reactive.

As there can be little working capital headroom in the industry, liquidity tends to be artificially propped up by termly prepayments – which, depending on how they are held, may not even form part of the asset pool (see below).

These institutions often appear superficially stable, but are, in reality, operating with minimal resilience to shocks that may arise. 

Demand pressures and demographic risk

VAT aside, many schools are dealing with a difficult market which has increasing challenges, such as:

• shrinking birth rates reducing the pool of pupils year-on-year, a structural issue likely to worsen into the 2030s;
• middle-income families are increasingly priced out, especially as mortgage and utility costs rise; and
• state sector improvements (including academies) are offering viable alternatives in many areas.

To compensate, some schools have turned to international students or overextending on bursaries. In both cases, the risk profile shifts, whether to currency exposure, visa regulation, unrecoverable discounts or domestic parents' dissatisfaction. These are not one-off decisions and are indicating systemic strain.

Prepayment, cashflow and trust structures: hidden liabilities for IPs

A key feature in this sector is the role of prepaid school fees.

While schools may account for these as income, in legal terms they are often trust monies, not general assets. This is particularly the case where:

• terms state that the funds are 'held' until services are rendered;
• deposits are explicitly refundable or for future performance; and
• segregated bank accounts or designated funds exist (formally or informally).

For insolvency practitioners (IPs), this has clear consequences:

• these funds may not be available to satisfy general creditors;
• using them to pay unsecured debts may be a breach of trust; and
• they are sometimes already spent, leaving a liability without corresponding cash.

This disconnect creates serious complications in cashflow analysis and asset composition, especially in schools that experience collapse in the middle of an academic year.

When distress turns to insolvency, legal and governance duties kick in

Many governors and trustees do not appreciate when the balance tips from distress into insolvency. IPs should remain alert to signs that boards may be:

• continuing to trade with no credible recovery plan;
• relying on unrealistic assumptions around fundraising or enrolment; and
• failing to consider their creditor duty (per Sequana) or the risks of wrongful trading.

Where charitable status applies, charity law overlays additional obligations, particularly:

• acting prudently with charitable assets;
• avoiding speculative trading at risk of insolvency; and
• ensuring transparency with stakeholders and the Charity Commission.

The regulatory framework does not insulate schools; if anything, it adds more complexity. Professional advisors brought in early can help pre-empt issues through contingency planning or exploring other options.

Board behaviour: why delay is so damaging

The opportunity to deliver a supported turnaround/rescue, orderly wind-down, managed sale, or strategic merger is often missed due to delayed action.

By the time legal advice is taken:

• the school may be unable to commit to a full academic year;
• staff and parent confidence may be lost;
• contractual refund obligations may arise mid-term; and
• key employees may have left or withdrawn cooperation.

These are practical insolvency risks, but they stem from a lack of advance planning, not the absence of options.

What proactive financial governance looks like

In contrast, boards that remain viable tend to do three things consistently:

1. maintain a rolling 12-18 month financial runway, including term-by-term scenario analysis;
2. stress test enrolment assumptions and cashflow quarterly, not just annually; and
3. engage with insolvency and legal advisers before the tipping point; ideally when the financial headroom drops below completing the next academic year.

Boards need to understand that once they can no longer commit to delivering a full year of education, the risk profile changes. Pupils, staff, and creditors are exposed, as well as trustees and directors.

Practical considerations

For practitioners, the following markers often signal a need for intervention, closer involvement or review:

• prepaid income has already been spent, leaving future liabilities with no cover;
• no viable path exists to bridge current losses within 6–12 months;
• external funding (eg loans from parents or foundations) is informal, undocumented, or non-binding;
• reputational or regulatory pressure is driving payment decisions that may prejudice creditors; and
• closure planning is absent, despite worsening headroom.

In many of these situations, options still exist, but only if decisions are grounded in legal reality, not wishful thinking.

Looking ahead: structural reform or continued attrition?

With birth rates falling and fee pressure intensifying, the sector is unlikely to self-correct without substantial adaptation. Turnarounds, mergers, shared services, and strategic exits will become more common.

IPs have a clear role in both formal appointments, and in helping schools and boards to understand when viability slips into legal risk, and when action must follow.

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