14 August 2020
The composition of the nearly 2.3 million SMEs currently operating in Australia is as follows: -
- 2,259,000 small business (defined as a business with 19 or fewer employees); and
- 50,000 medium enterprises (being a business between 20 and 199 employees).
Conversely, there are fewer than 4,000 large businesses in Australia and hence, the SME sector represents the largest employer in the Australian economy yet only about half of those businesses are incorporated as companies limited by shares. Last year, nearly 275,000 businesses came to the end of their lifecycle while approximately 350,000 new businesses begun operations. Sadly, around 75% do not make it to their 4th year and these numbers have been reasonably static for the past decade. So, ultimately, whilst insolvency is a common occurrence in the SME sector, only 50% of business owners enjoy the protection afforded by operating out of a company structure.
Often when an SME business commences, the owner or owners invest significant personal funds to start the business (i.e. to secure leasehold premises, buy plant and equipment etc). Most likely, those personal funds will originate from savings, an inheritance, a personal loan and/or drawing on equity tied-up in their house.
As previously established, a large proportion of SME business owners enjoy no legal protection from their business’ operating structure so, it is imperative that owners’ register the funds they inject into their businesses on the Personal Property Securities Register (“PPSR”). The PPSR enables funds personally injected by a proprietor to be recorded as a formal, documented loan and ultimately, provide owners with the confidence to continue to make investments in their business as and when required, with knowledge that if the business fails, they will likely be able to recover some or all of their personally invested funds.
A great majority of accountants and other professionals advise this course of action to SME-business owners however, the overwhelming evidence from Liquidators is that this advice isn’t being implemented. There are likely to be several reasons for this, including:
- Owners are not seeking advice from appropriately qualified professionals before starting their business;
- The advice does not extend beyond recording the owner’s loan in the business’ books of account;
- The owner’s loan and security has been correctly documented however, it has not been registered as a security interest on the PPSR; and/or
- The professional advice originally sought is not implemented because having documents prepared and registering the loan on the PPSR is prohibitively expensive.
None of the 4 reasons are commercially acceptable – especially when considering the significant difference as to what an owner would recover on the realisation of assets by a liquidator should the loan happen to be unsecured or unregistered versus a secured loan registered on the PPSR. This is due to the priority set out in section 556(1) of the Corporations Act 2001. The following table highlights those differences in a scenario that is typical in the liquidation of an SME business: -
What’s demonstrated that in the scenario above is that an owner would recover all of their unpaid investment funds in the event that their loan was registered on the PPSR. It should be noted that there is very little difference between not having a loan at all; and having a loan that is not registered on the PPSR. Importantly, the money that can be recovered by the owner can then be diverted to continue paying household bills or even to start another business.
Further, beyond merely increasing the owner’s chance of recovering their personally invested funds, registering a loan on the PPSR could allow their current company to survive and prosper again as it largely enables them to propose a viable Deed of Company Arrangement (“DOCA”) in the event of business difficulty.
Importantly, using a DOCA can be a successful tool in dealing with debt that has accrued during the Covid-19 period as the biggest obstacle to an owner proposing an acceptable DOCA is usually the amount of money that is available to deliver enough to creditors and to keep the company going during the administration period until the DOCA is implemented.
As a secured creditor, the owner is in a far stronger position in being able to affect the direction of the administration - which could include the acceptance of the DOCA. This is because the secured creditor will retain the secured assets - even if the DOCA it proposes is not ultimately accepted.
The secured creditor can also use the amount that it is owed to allow unsecured creditors to receive payment in circumstances where they would otherwise receive nothing (or very little) in liquidation by deferring its payment by the company.
The power owners have in the administration process as a secured creditor allows them to seek advice early and to plan for an orderly and quick process in order to rehabilitate the company and to begin to thrive again.
The other major benefits of being a secured creditor is that the cost of the Voluntary Administration and DOCA process will be less and allow the owner to maintain the continuity of trading the business throughout. The position as secured creditor also allows the owner greater bargaining power to work together with a bank and/or private financiers and to deal with things like guarantees given to trade creditors - interactions that can otherwise elongate and sometimes derail the process.
Simply let your regular Koustas & Co contact know - or our Business & Practice Development Manager Matthew Swannie - should you wish to explore this further.
With Worrells Solvency & Forensic Accountants
